Webinar: Sustainable investment - navigating the impact on fund governance.

Velina Karadzhova (VK): Hello everyone and thank you for joining us today.

I'm Velina, Head of the First Sentier MUFG Sustainable Investment Institute, and I will moderate today's Webinar, which will discuss our latest report: Sustainable Investment - Navigating the Challenges for Fund Governance. As the title suggests, we will be discussing if and how sustainable investments may be a cause for excitement for fund board directors

But before we dive into the topic, allow me to do a few introductions and the customary housekeeping points. In terms of agenda for the hour, Brandon Horowitz from Fund Boards Council will provide an overview of the report, followed by a panel discussion and we will leave some time for questions from the audience at the end.

Today's session is in listen only mode. Please use the Q&A function to submit your questions. The session will be recorded and made available through the Institute's and Fund Boards Council's websites as well as on social media.

Before I introduce and hand over to Brandon, a quick comment on First Sentier MUFG Sustainable Investment Institute, what we do and why we thought this is an interesting topic to look at.

The Institute is relatively new. We launched last year with the support of First Sentier investors and MUTB with the objective to increase awareness and encourage action on important sustainability-related issues that we feel could benefit from further research and understanding.

Our first two papers looked at the topics of microplastic and microfiber pollution, and with each of our papers we also try to provide some practical solutions and steps to the issues that we are looking at.

We're very pleased to publish our paper today, on board oversight of sustainable investment funds. We're all well aware of the significant growth in sustainable investments in the past few years and the growing level of related regulation.

But while arguably that doesn't really change the governance responsibilities of fund boards, we understand that the base and breadth of development has been somewhat of a challenge and we wanted to examine this further.

We hope that our report provides some insight into those challenges that fund boards are seeing at the moment and it offers some practical steps to strengthen governance.

The report is authored and researched by Brandon Horwitz of the Fund Boards Council and I would like to take the opportunity to express my thanks to Brandon and the team at the Fund Boards Council as well as all the individuals who took part in the research.

Brandon is a Senior Adviser and Non-Executive Director at FBC and he's involved in FBC's consultancy work with a focus on product governance, assessment of value and investment governance, including oversight.

So with that, Brandon, over to you to outline the report findings.

Brandon Horwitz (BH): Thank you, Velina and good afternoon everyone. I'm very happy to have this opportunity to present at today's event.

I'm speaking today on behalf of Fund Boards Council, or FBC as we are more commonly known. We're an organization exclusively focused on fund governance, promoting examples of excellence from the asset management industry where we find them and offering guidance, consultancy and training to firms who may need our help.

We actively support fund boards in delivering greater value, improved transparency and better governance for the investors. FBC has extensive understanding of the intricacies and nuances of fund governance and its role within the wider governance structures of investment management firms.

My own interest in the subject comes from over 20 years of being involved in retail and institutional investments in a range of roles, including investment consulting, investment management and banking, as well as roles as a regulator and being responsible for retail wealth management propositions.

I've always seen it as my duty, and our duty as an industry, to help ensure that we manage customers' investments to help achieve their goals. And that starts with ensuring that our products do what it says on the tin.

This sounds easy in practice, but we all know that investment fund labels and objectives have gotten progressively more complex in recent decades. This makes it a challenge even for those of us in the industry to agree what the label on the tin actually means.

We probably all recognize this challenge when it comes to sustainable investments, sustainability can mean different things to different people. And this means that fund investors and intermediaries could have a very different understanding and expectation of a sustainable investment fund compared to what the fund provider actually intended when they made the fund. And this results in the risk of the fund provider being accused of greenwashing.

Addressing this risk of greenwashing is one of the primary drivers for us having undertaken the research that we've done. Other drivers include the phenomenal growth in sustainable investment funds. Assets under management have more than quadrupled in the past three years and we continue to see increasing regulation in this area.

We concentrated our research on retail-focused sustainable investment funds in six jurisdictions, including Europe and Asia-Pacific.

Retail investors choose pooled investment funds to access the expertise of investment professionals and the many other benefits which come from this well-established and highly regulated type of vehicle, including strong governance requirements. One of these key requirements is that those who manage pooled funds must act in their investors best interests. This includes striving to meet the funds stated objective, including any sustainability-related promises.

It's worth noting that the structure of funds differs in some respects across jurisdictions. However, they all have a common feature - the buck stops with the fund board who has ultimate accountability for the fund. Therefore, we focused our attention on the fund boards themselves.

To think about how can we help them improve how they oversee investment funds through three things: exploring how sustainability considerations fit into the fund board's responsibilities, identifying the challenges which fund boards face when it comes to sustainability, and suggesting practical actions to help them to navigate these challenges.

To do this, we interviewed 25 fund board directors and other fund board professionals to understand the way that they oversee these funds today. We also undertook desktop-based research on the relevant regulatory and legal requirements.

So what did we find? A major focus of our work was how fund boards oversee whether a fund is delivering on its commitments to investors. The first challenge that we identified was the simple fact that it was unclear as to what role should the fund board play when it comes to ensuring that sustainability promises are actually being kept. We identified a number of actions which can help to address this challenge, including ensuring that funds have clearly articulated sustainable investing policies, especially in terms of how these policies help to achieve a fund's objectives ensuring that the fund board understands and has confidence in their investment manager's approach to assessing sustainability.

And finally, and arguably very importantly, ensuring that the arrangements to monitor fund performance explicitly consider sustainability naturally for funds which have sustainability features.

If we turn now to regulation, as many of you will be aware, detailed rules and guidance applied to sustainable investment funds, especially when it comes to things like fund names, how the funds are labelled or classified and what product documentation is provided to customers pre- and post-sale.

Our second major finding was that some boards were relatively remote from how these regulatory activities are actually being addressed. The fact that these fund boards are not aware of how the regulations are being met arguably leaves them exposed to significant risk because ultimately they will be held accountable for any shortcomings in compliance. Fund boards can address this risk by satisfying themselves that sustainability requirements are properly incorporated into product governance frameworks, including when the fund board considers proposals for new funds and especially when they receive requests to repurpose existing funds as sustainable investments.

It's also important that fund boards satisfy themselves that the controls around funds documentation and mandatory reporting remain effective, especially given the increasingly demanding requirements for sustainability reporting.

And this leads us naturally to sustainability data which is key to reporting. But as many of you will be aware, sustainability data presents significant challenges today. So fund boards really need to ensure that they are aware of the limitations of the sustainability data being used as well as what data integrity controls are in place.

Now, our work leading to the second finding covered regulatory risk and data risk. But we quickly realized that sustainability impacts risk management in general for fund boards. This is because fund managers are increasingly required to consider and disclose how they have assessed sustainability risks, and climate change risks in particular, at both an entity and product level.

Our research in this area led to our third major finding, the fact that some fund boards have not considered how sustainability risk is managed, both within portfolios or the way it's included in the way the fund considers risk management in general. We identified a number of actions which can help to address this finding. Specifically, the suggestions that fund boards need to ensure that sustainability risk is incorporated appropriately both into how their investment manager considers it in portfolio management and also the way their entity includes it within enterprise risk management frameworks and governance arrangements. By doing this, fund boards can help ensure that all of the risk management functions are effectively addressing sustainability-related risks. And this includes the role of risk functions in assessing key controls such as those which ensure that funds are true to label, which in turn, of course, will address the risk of greenwashing.

Our final area of focus was the composition of fund boards themselves. Our research identified that some fund boards were at an early stage on their journey when it comes to things like developing an appropriate level of knowledge and understanding of sustainability regulations, building their awareness of the different approaches to sustainable investing and developing an appropriate knowledge of the key tools and metrics which are involved in sustainable investing. We think that fund boards can remedy these issues relatively swiftly, for example by undertaking board assessments to identify gaps in sustainable investing funds knowledge, skills and experience and then addressing these gaps, for example by arranging training or deep-dive board sessions with the investment teams and other professionals. We also suggest that some fund boards could benefit from recruiting a subject matter expert on sustainability matters and there could be value in this person being an independent member of the board.

Now, I appreciate I've covered a lot of information in the past few minutes and don't worry if you haven't taken it all in. It's all in the report. There's a very neat executive summary and please go ahead and download it and we hope that you do find it useful on your board or elsewhere in your organization. I'd really like to thank First Sentier MUFG Sustainable Investment Institute for the opportunity to work with them on this important topic.

And I'll now hand back to Velina. Thank you.

VK:  Thank you very much Brandon. Really quite a bit to take in but I guess that just illustrates how complex the issues may be in practice. And speaking of practice, I would invite our panellists to join the discussion as each of them brings that practical perspective and from a slightly different angle too.

Allow me to just quickly introduce them first - Clare, Sheenagh and Will.

Clare Wood is Global Head of Product for First Sentier Investors and sits on the Board of Directors of some of the FSI entities and collective investment schemes in Europe and she has over 20 years of experience in asset management.

Sheenagh Gordon-Hart is a partner in the Directors' Office in Luxembourg and serves as an independent director on a number of boards in the asset management industry and her areas of expertise include regulation, governance and distribution.

And last but not least, Will Oulton. Will is the Global Head of Responsible Investment at First Sentier Investors. He has nearly 20 years of experience in sustainable and responsible investment and sits on a number of investment advisory boards and committees.

So thank you to all of you for joining today and I've got some questions to put to all of you in due course, but I will also keep an eye on the questions coming through the Q&A, so we will try and address those either towards the end or, if it fits better, as we go along So please do feel free to put any questions that you may have in the Q&A box.

So maybe let's start by just taking a step back and reflecting on that huge growth in sustainable investments. What is driving this and what are the implications and challenges for fund board directors? Will, if you don't mind, I'll address this one to you.

Will Oulton (WO): Sure.Thank you Velina and good afternoon everybody.Thanks for joining us today. Brandon, thanks very much for the summary of what clearly was an extensive piece of work. So thank you for you and your colleagues for putting all that together.

Brandon mentioned that the last three years has seen some impressive growth in sustainable investment, but this has been going on for quite some time. I think there was a step change in growth with the introduction of what is known as the EU Sustainable Finance Action Plan. There are a number of components to that plan and one of them is known as SFDR, which is the Sustainable Finance Disclosure Regulation, which was introduced in March 2021.

And since then we've seen a vast range of activity right across the European market, but also replicas of that regulation appearing in jurisdictions around the world. So it's seen as real pioneering advancement of a regulatory framework that has been adapted to promote increasing private capital into sustainable investments.

Now, it's complex. Its rollout has been, I think, somewhat chaotic at times, but it's certainly been a key factor in this step change in growth in sustainable investments, certainly across Europe and in other jurisdictions.

For those not familiar with SFDR, it essentially requires financial products to be categorized into three different types of financial product and they're known in sort of EU speakers, article Six, Article Eight and Article Nine. So if you haven't heard those terms before, I'm sure you will going forward, particularly around this topic.

And the difference between them is that Article Six is a sort of basic ESG integration approach. So if you think of those familiar with the PRIs principles, that's essentially that level of integration of ESG into an investment process. However, the two other categories are where all the key challenges and interesting developments have been.

Article Eight funds are those that specifically promote either an environmental and/or social characteristic in the investment process and objectives of that fund. That has to be monitored and reported on how those characteristics are being met. And that is a binding obligation because it's in the legal documentation. That's what will happen in the management of that particular product.

Article Nine are those which have a sustainable investment objective.

Now, one of the things to note when looking at this whole picture is that there's an underlying policy objective behind all of this regulation. And there are three key things.

One is the EU meeting its Paris climate agreement. So it's heavily biased, at the moment, towards its environmental disclosure requirements.

The second is the EU block's support of the Sustainable Development Goals.

And the third that Brandon touched on, which was mentioned in the report, was greenwashing. And I'm sure we'll talk about greenwashing in a little while.

So in terms of the growth, at mid-year this year, article Eight and Nine funds, approximately around 50% of the AUM across the EU. Now that is a phenomenal growth in a very short period of time. And not only that, it's that the regulation is spurring product development.

There's certainly a bias now towards launching or repurposing, as Brandon said, funds into Article Eight and Nine. And there's a sort of commercial drive for that.

And one of the things that this repurposing has done, has provided particular challenges, I think,  for both boards about the rationale and the kind of integrity of that process of repurposing. And just in Q2 alone this year, there were some 700 funds which were repurposed from Article Six to Eight and Nine.

So I think that the challenges for fund boards in operating that oversight role is this is a complex area now and it's fast-moving and it's been an astonishingly rapid pace of change we've witnessed in the last two years. It's unprecedented, I think, in the industry, in the application of such wide-ranging disclosure-based regulation. And there are many more components to SFDR in this plan that we won't have time to talk to today.

But with that comes a level of ambiguity. Sustainable investments are defined in the regulation, but quite open to a range of interpretations. So fund boards are going to have the challenge of giving some credibility and oversight to those different applications of the investment managers to what is an ambiguous set of definitions.

So in essence, this complexity, this pace of change is actually bringing regulatory and legal risk with it. Which is why it's a topic that I think fund boards should actually really begin to focus on more than they probably have in the past.

VK: Thank you very much Will. And I think listening to you and Brandon earlier, it seems that sustainable investments present challenges at multiple levels for fund oversight. And I think the findings from the research and Brandon touched on it a little bit, suggested some fund boards may be actually at the start, or have a long way to go before being effective at overseeing sustainable investment funds.

 Sheenagh, I'll come to you with the next question.

Do you think that this is a fair assessment based on the boards that you work with?

Sheenagh Gordon-Hart (SGH): Yes, I think it is. Thank you for that question.

I think there is a range of capabilities across boards - that's not in doubt. And it is fair to say that every board is at a different stage in what is going to be a long journey because I don't think we quite know where the destination is for a lot of this.

Will mentioned that there is ambiguity, in some respects that's true, but also there's an awful lot of prescription there and a lot of fund boards are finding it very challenging to get around the level of prescription that's there.

Now, to be fair, I think the fact that there's been such enormous growth in assets with the sustainable label of one sort or another is testament to the fact that asset managers are really committed to this. And there are a number of asset managers who have been on a sustainable journey for longer than the European Commission, let's put it that way.

Sustainability didn't originate with politicians but actually originated in the market. And so what we're seeing is a whole range of capability across asset management and that is reflected in a range of capabilities across fund boards.

I think everybody is committed, but the resources to meet the challenge are sometimes a problem and time is short. And I don't mean time in terms of the Paris Accord, I mean time in terms of actually meeting obligations under SFDR. And so I've seen fund boards really, really struggle, in some regards, to actually be able to adopt and adapt to all the requirements and some who find it very easy. But even those who have been committed for a very, very long time to sustainability and ESG are finding these demands enormous.

Actually putting it together in a coherent way, in terms of reporting, is a challenge and I'm not sure that we are always able to distinguish between what is realistically achievable and what perhaps politicians and policymakers expect. There is a gap there and I think there will be a gap there for some time to come.

VK: Thank you very much, Sheenagh, for that perspective. And I think listening to the three of you, varying definitions cropped up, differences in investment approaches cropped up, greenwashing came up in the conversation and the expectation gap as well between policy and policy and industry.

Will, if I can come back to you, with the next question. How big of a problem is greenwashing actually?

WO: Well, I think it depends who you ask, but it's certainly a feature of the industry today.

As we've just talked about, there has been a rapid growth in a very short space of time around sustainable investment. I completely agree with Sheenagh that this is not a new phenomenon. The discipline around integrating ESG has been around for quite a long time and the range of products has been growing over time.

But there has been this step change and it has been triggered by this focus on regulation. And with that growth has come concerns about the issue of greenwashing.

Basically what it means is the practice of making false or unsubstantiated sustainability and ESG related claims about products, the investment activities or policies. And there is no kind of formal definition of greenwashing, and in a minute and we can pick up on whether that's a good thing or not. But I've seen examples since March last year.

One that I always kind of remember was there was an asset manager that put a kind of communique out shortly after the introduction of the SFDR, saying that they'd been awarded the Article Nine categorization for their products because of their history of excellence in sustainable investment.

Now that, you could argue, is a form of greenwashing because you don't get awarded the SFDR categorization and it's got nothing to do with your credentials, of how good or not you are on this.

And this has come to the attention of regulators. It's one of the priorities for the FCA, it's one of the priorities for the European regulators. So much so that the European regulators have asked, the Commission have asked the European regulators to provide evidence of greenwashing and asking whether they have the tools and the powers to actually address it.

Now, one of the reasons they're concerned about this is back to the policy objectives in the EU, in that if greenwashing persists and there's a loss of confidence in sustainable investments across the industry, then they're not going to meet the policy goals. Which at the moment, with the flows going into more sustainable investments, they're reasonably happy are being met. So they're very, very concerned about this because they believe it will undermine the capacity of the financial system to channel capital to sustainable investments to meet those sustainability goals.

So I think for fund boards, this should be of great concern, particularly in relation to the sale of financial products to the end user. Where fund boards have got accountability, it can trigger a level of operational and legal risk to the seller of the products and that should certainly be a trigger for extra attention from fund boards. So the regulator's response to addressing greenwashing today has been an enhanced disclosure.

And again, as Sheenagh mentioned, it's complex and it's difficult to know exactly what is required to be produced at any one time. Some of it is mandated, it's not optional, but others, the industry still navigating their way through that.

Layer on top of that, the problem that Brandon described in his report of the quality of the ESG data, then you've got a potential kind of mix of horrible things all happening at once.

So I think for fund boards it would be helpful in their deliberations to enable the distinction between intentional greenwashing and unintentional greenwashing. And there is a difference. People can make mistakes or just not think through the implications of what the promotion or the marketing activities or communications around funds are. But some guidance to what constitutes greenwashing from regulators with some examples I think will be very helpful and welcome.

VK: Thank you very much. Certainly a complex problem and, Brandan, I think it would be helpful to hear from you here whether that's consistent with the findings from your research and whether greenwashing is, at the moment, a topic in fund board discussions.

BH: Thank you, Velina, and it's a really interesting question, I'd have to say, from all of our discussions, greenwashing was certainly there in the background and all the people we spoke to thought it was a risk. But when we then probed a bit further to understand is it something which is being actively addressed at the fund board, we got a very different picture.

And by and large it was very, very clear that the fund boards were not very close at all to the way this risk was being managed. From the practical point of view that it's seen as something which the Executive does. It's generally seen as the perception that the Executive be it investment committees or risk committees or someone else is looking at this. Which is absolutely fine if we were in a situation where this is something which was quite well-defined and it was quite mature.

But one of the reasons why we think this merits attention is exactly as Will, and as we've all been saying, there's variability in what sustainability could mean. And this is not an area where firms have very mature controls or, in fact, are able to articulate very specific controls.

There was only one exception, which was one firm where the board was responsible for a number of Article Nine funds and in that case they were very much on the ball. This was something which was keeping the director up at night and they saw quite a lot of information about it because they really wanted to be sure that these funds did what they said on the tin. But that was very much the exception from all the discussions that we had.

The general lack of management information or any sort of really detailed discussion at the board of this was a bit surprising, to be honest. And I think that's one of the reasons why we felt it's worthwhile doing this research to really bring it up to attention and to suggest that people might want to think about if, wholly placing reliance on the executive, without asking questions about how they're getting on with it, and satisfying yourself as a board that they're getting on with it in an effective way, is that perhaps just a bit too risky a way to go about doing things.

ZK: Thank you very much, Brandon. It's a fine balance, as a fund board director between micromanaging and ensuring that there is actually effective controls in place, and if those are at an executive level, to ensure that the funds are managed as intended.

Sheenagh, if I can come back to you with the next question. Do you have any examples from your experience, perhaps, how that balance between micromanaging or oversight has been found, or maybe it hasn't been found yet on some of your boards?

SGH: Well, I think there's a difference in practice, but one thing that I think is interesting is that those fund boards, those asset management groups that have ESG and sustainability as part of the culture, are much more engaged from the get-go with their boards around how they address these issues and how they intend to meet their regulatory obligations. With others, perhaps it's more of an afterthought, but every independent director should be asking those questions.

What we all want to see is these principles embedded within the organization. Right now, a number of my fund boards are running seminar programs to ensure board members are up to speed, both with the program that meets the regulatory obligations right from the product governance side to the distribution side. And that's really important. Others perhaps need to be dragged to the table, but ultimately we want to see all of these considerations as part of BAU eventually.

But everybody's got an education process to go through to recognize the particular attributes of ESG in investing that make it different and how then that can be integrated into MI for the board as a whole. But it's interesting to see the different approaches.

Some of my fund groups have had regular, I mean, two or three times a year, additional half day programs of education, and that has been extremely helpful and valuable to the board members. Others perhaps not so much, but everybody will get there, because, as I said before, I have absolutely no doubt that the asset management industry is committed as a whole to ensuring this is part of the future.

VK: Thank you very much. Very interesting insights from you there.

And as we mentioned, controls, processes at an asset manager level. I think it is a good place to bring Clare in into the conversation. Claire, from your perspective as head of Product and someone who's actually dealing with those issues on the ground within an asset manager, could you share experience or observations on how asset managers are addressing these issues in terms of internal governance or any control procedures?

Clare Woods (CW): Thanks, Velina. It was interesting to hear from Sheenagh about the different range of experiences she's seen. So if I give what First Sentier are going through is a bit of a specific example

We are currently reviewing and considering all aspects of our internal product governance framework to make sure that ESG and sustainability commitments are explicitly captured in that. So it probably involves key three areas in that framework.

Obviously, we've got existing Responsible Investment committees which cover this kind of thing and can be adapted to ensure that we're focusing on the right thing from a regulatory perspective as those regulations evolve.

Two other key areas, I would say, are product governance forums that sign off things like fund launches, fund changes, fund naming. It's making sure that those ESG and sustainability considerations are explicitly captured there. And then as a post-launch piece, there's the internal oversight of what's going on in the fund.

So, as an example, we have a global investment committee that was set up many years ago and historically focused on all the things you'd expect an investment committee to focus on, such as performance, risk positioning, liquidity, etc. Over the last year or so we have been explicitly adding sustainability factors and considerations into that committee so that they're considered in the same forum that we consider all of these other metrics related to the funds.

And as a sort of parallel piece of work to do, we need to make sure that we've got the right resource in these internal teams, so this ability to understand and focus and question around ESG can't just be consigned to a Responsible Investment team.

We've got to make sure that we've got that capability in, say, the investment risk team, where it flows across to the risk team, the compliance team, etc.

Putting all of those together, along with a governance framework that links up the pre-launch and the post-launch activities should hopefully put us in a good place to ensure that we're making sure there's no greenwashing within First Sentier Investors.

ZK: Thank you very much, Clare. And I think listening to all of you, there is a lot going on at board level and there is a lot going on at asset manager level, so at all levels basically. Clare, if we are to link what's happening at asset manager level, just go back to the board. And we did look at suggestions or ideas of management information within the report which could give boards assurance that sustainability funds are being invested as they are supposed to. In your experience, is there any particular example of management information that you find particularly useful, particularly effective, for gaining or giving that confidence to the board?

CW: I would say, as with all board reporting, it's important to get that balance between offering sort of too much granular detail to the board versus offering them enough to really be able to challenge. And there's so much data and so many metrics out there when it comes to ESG and climate change that it's really important to get that balance right.

And to Sheenagh's point, to report in a coherent way so that the board can make sense of it. I'd say there's probably two areas that we've been looking at within FSI.

Will had mentioned there's a sort of ambiguity in some of the regulations, and certainly there's no formal definition of what a sustainable investment is that's provided by the regulator. So each asset manager is coming up with their definition of what they think is a sustainable investment. I think the board needs to be across what that definition is, how the asset manager is defining a sustainable investment, and be able to challenge that to make sure that it stacks up and makes sense and is consistent with the regulation, but also with internal practice within the asset manager.

I think another really fruitful area of reporting, actually, particularly when it comes to SFDR, is the Principal Adverse Sustainability Impacts. I think asset managers are generally really, really good about talking about all the good things they do. So they like to talk about all of the positive impacts that their funds have and the great things they're doing. I think that Principal Adverse Sustainability Impacts data just shines a really interesting light on what a fund is actually doing.

And it's not to say that a lot of these metrics, there's no black and white sort of thresholds to cut off, but what you're really looking for is a sort of high quality discussion with the board around, well, "why have we got this data in this Article Nine fund?" "Why is there this percentage data coming through?" "What are you investing in?" "Why is it okay?" "Why do you think it's okay?" And again, being able to try to provide the challenge at that level. And I think that's going to be really important as these regulations evolve to be able to demonstrate that rigour.

VK: Thank you very much, Claire. If I'm to summarize the discussion so far, there is just a lot going on, and it seems like everything is probably a bit of a moving target, with regulation certainly changing fast. And you did mention a few times.

So when it comes to sustainable investments, regulation is not the only area that boards would need to have expertise in. You mentioned metrics and data, and I think we heard that from Brandon and Will earlier as well. So understanding the different investment approaches or understanding what the asset manager's interpretation of sustainable investment turns out to be.

And with all of this, Will, I'll just come back to you with someone who has been in the industry and dealing with sustainability for a long time. What can fund boards actually do to catch up on all of that and get up to speed and equip with sufficient knowledge in ESG and sustainable investing?

WO:  Thanks Velina I think this is the sort of forward-looking part of the work that's been done in the report really is how do you future-proof the capabilities of boards to deal with what is clearly an increasingly complex area of the industry.

I think one of the challenges will be is the talent pool certainly in the industry for anybody working in investments related to having ESG knowledge or experience. There's been a huge demand and a very limited supply and I would guess this is even more exaggerated when it comes to the independent director pool of talent that fund boards go to select from. So I think there is an issue certainly to be addressed and there's three things I would suggest for purpose of this conversation that should be looked at.

One is around training, but I think there should be a very kind of specified defined schedule of training and there are certain things that should be on there as a minimum. So one should be climate risk and what are the key indicators and how do you interpret key indicators to assess climate risk? And that should include the issue of scenario analysis. It sits in the climate risk law in the UK for pension schemes. They've got to do that every three years. Many of the industries provide services to those clients. So understanding what that is would be a minimum sort of requirement.

As Clare mentioned this concept of Principal Adverse Sustainability Impacts. They are a mandated feature of the EU system. They will sort of also appear in different jurisdictions. Understanding what is the profile around these adverse impacts of funds would be very useful for fund boards to know. Also, the narrative around this concept of do no significant harm to the sustainable investment objectives.

That's an area that, again, should be a focus on in terms of understanding why that is in this regulation, what it's intended to do and scrutinizing the disclosures around and what data is being used to exhibit that. As well as just generally road-mapping the regulation change to expect that is coming in the industry that boards can prepare for the different components of that as it gets rolled out.

The other thing I think is in terms of the recruitment process. I think it would be very wise for fund boards now to have, as part of their profile for certainly independent directors, an expectation or an ask of some level of awareness. Not expertise because I think it would be very hard to find but some level of knowledge and awareness of this topic would be a good thing to signal to the recruiters who operate in this space that this is an important feature and it's going to grow.

And then finally, I guess a bit like what you find with pension fund trustees, a sort of certification of competence program that exists. I think there'll be a time, hopefully in a not too distant future, when such a scheme would be helpful in the identification and recruitment of independents. That could show some level of knowledge and awareness to boards and the recruitment agents that they get this and they understand the issues.

I'd be interested in Sheenagh's views. She might have a very different view of that. I wouldn't advocate for specialists to be on independents, but certainly some level of knowledge and competency. But I'll wait for Sheena to either shoot me down or agree with some of it next.

SGH: I think that's really interesting. If I could just take you up Will. I think to have ESG specialism on the board is probably a big, too big, of an ask because as you suggested we're dealing with a very broad range of issues. The social versus the environmental versus governance.

You can have a whole range of expertise there and of course it's important to be aware of all these issues and I think you touched on it there. Training I think is crucial and I think that is not just training on the part of the sponsor, perhaps the asset manager, but also I expect independent directors to be interested in getting themselves trained as well.

And there are a lot of very valuable certifications out there, a lot of very valuable courses that you can go on that help to broaden your appreciation of the demands of ESG and sustainability and I'm all for that. It is a profession now to be an independent director. It's no longer a sinecure, which it may have been many years ago, and therefore you owe it to yourself and to your professional capability to keep yourself well informed. So that's important.

But also it's really also important for boards to bear in mind they need to avoid groupthink. So sustainability has a range of very important goals, but independent directors are there to constructively challenge and that has to be part of the process. And I think too much expertise in one area on a board could actually dampen that inquiring nature of the independent director.

So I don't disagree with you, Will, I just think the emphasis needs to slightly shift and I expect independent directors to be engaged and to ask all of these relevant questions and to be interested in the ultimate outcome, which hopefully is a better investment profile for the industry and for our clients who actually are the objective of this.

VK: Thank you very much. I'm mindful of time. We have just about ten minutes left, so I'll probably just pick a few questions from the audience.

I'll start with one we've got here and I think, Brandon, that's probably one that you could pick up.

"It sounds like fund boards need to consider how they seek and get assurance within the insurance supply chain. How should the executive and board members work together to provide the assurance required?”

BH: I think it was one of the first questions that I was certainly asking, and all the people who I interviewed, and this was across 21 organizations, 25 people, I asked the same question, which is, is testing for the controls around addressing sustainability or avoiding greenwashing? Is it on your compliance monitoring plan for the next 12-18 months? Is it on your risk deep-dive plan or is it on your internal audit plan? And the answer from pretty much everyone I spoke to was no.

“But Brandon, that's a really good idea. Maybe it should be.”

And to me, that really just shone a light, which is the board is facing such assurance on the first line and saying the first line risk management team, the performance monitoring team, they're on top of this brand.

There's a Russian phrase which I quite like, which is “trust but verify”. People who know their history will remember where that featured.

And I think, of course, it's all right for you to trust your first line, but verify, get that validation, get that assurance that they're doing what you think they're doing.

And if you look in our report, in the risk section, there's a neat little table on page 28. You'll forgive me for plugging it, we've got some suggestions there for what could be done.

The first line teams should be putting in place the kind of controls that you would expect to check that all requirements are being met, and that's even things as simple as where each investment team says that they integrate sustainability well, how do they integrate it? And periodically, perhaps annually, going to each desk and making sure that they can demonstrate how they've integrated and that they actually do what it says on their tin.

And even things like making sure that any statements in marketing documents or  prospectuses and other documents validating that these are actually able to be defended.

And then, of course, the role of the second line is to go and check whether these first line controls are operating effectively. And then the third line, again, is that additional level of assurance.

So if there's one message that we wanted to get across it's if this is not on your three lines of control discussion, if it's not on plans for control testing for the next 12-18 months, you might want to think about whether it is or if it's within your risk appetite not to be testing some of these controls.

VK: Thank you very much, Brandon. And we do have another question here.

How should a fund board best guard against an over-zealous marketing department making claims about ESG out-performance which subsequently and with hindsight proved to be overdone?

SGH: I'm happy to kick off with that, I think yes, that's always a problem and we have seen the commission remind the industry that Article Eight and Article Nine are not labels.

However, it's very difficult to avoid them as labels because we need shorthand to be able to describe what we're doing and I think they've been a bit too aggressive in denying that they are labels.

Of course, ultimately the promise of a marketing department will always be looking to be positive but that applies to performance overall. It's not just about sustainability.

Obviously what you don't want is unwarranted or indefensible claims to sustainability that would result in a heightened greenwashing risk and that really is a matter for the board to be vigilant and that goes from prospectus all the pre contractual documentation onwards and so that's very important and KIIDs and soon to be PRIIPs will be part of that and everybody in the organization should be on the same journey.

Everybody's journey is different, as I say, but everybody in the organization needs to be on the same journey at the same time and that means marketing departments are bought into it and I want marketing department to be bought into this. I want them to engage properly and to meet the aspirations of clients in a way that is, well, I suppose, sustainable for the organization.

But I'm pretty hopeful that boards and executives can work together to make sure that that happens and they deliver. I don't know Clare, if you take a different view on that.

CW:  No, I think that's a good summary.

I mean the question of getting across marketing material is always a challenge, generally speaking, looking internally as an asset manager, you've generally got very good controls around offering documentation and prospectuses that provide that ability to provide that governance.

Marketing has many channels for it to get out of an organization into the public domain, so it can be a real challenge and there's always, you could be kind and call it an excess of enthusiasm, for asset managers, for their products as well, where they like to sort of make claims about the offering.

So it's a constant challenge and it's one that we, as I mentioned, we're looking at reviewing our internal governance framework and we will explicitly bring in the oversight of marketing material to that because it is so important and carries so much risk that we want to make sure that we don't do that wrong and make mistakes.

WO: I think if I can add a final comment on that, the EU system is quite clever in a way in having the requirement to disclose on an annual basis the performance of the Principal Adverse Sustainability Impacts data and why that could be helpful in guarding against the overzealous marketing claims (and I think it's a great question) is that you can't hide from that data that's got to be disclosed as part of the regulations.

So if there's an overzealous marketer who's saying "we've had brilliant climate performance in this fund, we've done superbly well", yet you see the carbon profile or performance of that fund actually getting worse, then there's no hiding from that. That information will be in the public domain. It's mandated in the regulations.

So there is a kind of check and balance built into the SFDR quite cleverly in a way, to guard against that. Now, in practice, will that happen? We will see next year when the full gamut of reporting is required in the first offer next year. So there will be a tsunami of information which will hit the market around ESG and sustainability performance from SFDR. It will take some unpicking and will be a real challenge to interpret, but that's one element of it that could be used for that kind of purpose.

VK: Thank you, everyone. Thanks to everyone for the contributions today.

Clearly, sustainable investments will stay and continue to be debated. So for those of you who would like to see more detail on the issues and what we discussed today, the report is available on the Institute's website.