– The regulatory risk associated with greenwashing in the ESG fund industry has reached a tipping point.
– Investigations by the SEC and German regulator BaFin into allegations of ESG integration overstatements by Deutsche Bank’s DWS have resulted in real-world consequences.
– DWS stock fell ~15%, causing a €1.2 billion market cap loss that has yet to be recovered.
– The Financial Times raised concerns about potential mis-selling by DWS in the UK, further amplifying regulatory fears in the sector.
– The trans-national nature of regulatory scrutiny is evident, with BaFin launching its probe after the SEC investigation began.
– The Financial Conduct Authority (FCA) has urged UK asset managers to ensure adequate resources for ESG fund products.
– Managers must balance the parabolic growth of the ESG fund sector with increased costs and regulatory risks.
– Asset owners and regulators are placing more importance on a manager’s ability to demonstrate the integration of ESG considerations into fund products.
– Three key priorities for asset managers running ESG funds include controlling costs, demonstrating integration at the fund level, and ensuring appropriate quantity and integration of ESG inputs.
– The diversity of fund objectives and ESG factors applied to funds poses challenges for managers.
– Frost Consulting has developed a three-dimensional framework for valuing and allocating ESG inputs while integrating them with fundamental research.
– Managers that can meet the challenge and demonstrate true ESG integration will be well-positioned to capture growth in the ESG category.
The environmental, social, and governance (ESG) fund industry is facing a breaking point in terms of regulatory risk associated with greenwashing. Recent investigations by the Securities and Exchange Commission (SEC) and the German regulator BaFin into allegations that Deutsche Bank’s DWS overstated the ESG integration of its funds have resulted in real-world consequences.
On August 26, 2021, the press reported the investigations into DWS, causing a significant impact on the company’s stock. DWS shares fell approximately 15%, wiping €1.2 billion from the market cap, and the stock has yet to meaningfully recover. The Financial Times also raised concerns about potential mis-selling by DWS in the UK, adding to the tremors of fear reverberating throughout the sector.
This enhanced regulatory scrutiny represents a sea change in the industry, with cross-national implications. The SEC’s Climate and ESG Task Force launched its investigation into DWS, prompting BaFin to commence its own probe. The trans-national nature of this scrutiny highlights the need for regulators to address allegations against companies under their direct supervision.
Prior to the DWS news, the Financial Conduct Authority (FCA) urged all UK asset managers to ensure that their ESG fund products were adequately resourced. This highlights the need for managers to balance the parabolic growth of the ESG fund sector with the higher costs and potentially significant regulatory risks involved.
One crucial aspect for asset managers running ESG funds is the ability to demonstrate how fundamental and ESG considerations are incorporated at the fund level. It’s not enough for ESG criteria to exist in isolation; a portfolio requires other fundamental data for effective management.
Furthermore, managers must ensure that the quantity of ESG inputs and their integration is appropriate for each fund product. This can vary significantly between funds, and managers need to navigate the diverse objectives and ESG factors applied to their products.
Recognizing these challenges, Frost Consulting has developed a three-dimensional framework for valuing and allocating ESG inputs while integrating them with fundamental research. This framework aims to demonstrate to asset owners and regulators that a manager’s ESG products have sufficient and appropriate inputs, while also addressing cross-subsidization issues.
Successfully meeting the challenge of true ESG integration and demonstrating it to asset owners and consultants will position managers well to capture the growth potential in the ESG category. As the importance of ESG objectives continues to grow and regulatory scrutiny increases, managers must adapt and evolve to ensure compliance and transparency in their ESG fund offerings.
Overall, the regulatory risk associated with greenwashing in the ESG fund industry has reached a breaking point. Managers must address these risks and prioritize the integration of ESG considerations into their fund products in order to succeed in this evolving landscape.
