Culture, ESG, Diversity and Inclusion – ethics is now more important than ever in the asset management space. To investors and policymakers alike, it’s not only about investment performance.
When the On The Regs team started thinking about the increasing role of ethics in asset management, we couldn’t help but think of the popular TV show: The Only Way Is Essex. For those on the other side of the pond, it’s Britain’s answer to the US-based Jersey Shore. Viewers of these TV shows see people behaving badly, a luxury not indulged within asset management, and a reminder that the only way is ethics.
Asset management is built on a foundation of trust. A decade ago, much of that trust was shattered by the global financial crisis. Firms and regulators alike have spent much of the last decade rebuilding trust in the financial system. A combination of technology and regulation have increase transparency and accountability for asset managers across the globe. Now, investors expect that business models, investment philosophy, incentives, and general corporate principles align with their own values. Thanks to both these priority shifts and the rise of millennials into both sides of investment process, a new vernacular has emerged within asset management covering ethics, purpose, culture, and stewardship.
What’s Your Purpose?
In his annual letter, “A Sense of Purpose,” BlackRock CEO Larry Fink laid out ethical imperatives in stark, simple terms. Fink suggested firms and companies seeking investors must do more than pay lip service to environmental, social and governance (ESG) issues. Fink warned firms “will ultimately lose the license to operate from key stakeholders” should they not heed the winds of change. Fink added that “companies must understand their societal impact” and states “without a sense of purpose, no company can achieve its full potential.”
The Next Generation
Achieving that full potential through finding purpose is particularly necessary for engaging with millennials, the next generation of investors. With the transition of nearly $30 trillion globally to this new generation of investors already underway, engaging with millennials is increasingly business critical for asset managers. Enshrining actions aligned with their principles is a must.
Regulators across the globe have spoken at length about the importance of culture. Culture is difficult to define and even harder to regulate. However, regulators are giving it a shot – and several policy initiatives illustrate the point.
- The UK Corporate Stewardship Code (the Code) was a first-of-its-kind regime for all UK corporate entities on shareholder engagement; it remains the global industry best practice. Its aim is to enhance the quality of engagement between investors and companies to help improve long-term risk-adjusted returns to shareholders. Regulators have rolled out similar stewardship codes in Australia and Japan.
- Meanwhile, the EU Shareholder Rights Directive (SRD) will bring corporate stewardship of more than 8,000 EU-listed companies to a new plain when enacted in 2019. SRD dramatically increases transparency to shareholders of the governance activities of asset managers and their underlying investments. European industry groups have already begun preparing for SRD and managers should pay close attention to it wherever they are based.
- The Financial Conduct Authority (FCA) recently published a discussion paper intended to start a debate on transforming culture. It explores broad themes including: culture as a valuable differentiator, a top down approach to transformation, and the importance of a client-first mentality. Additionally, the FCA implemented the Senior Managers & Certification Regime (SM&CR) in 2016 and plans to expand its remit later this year to include more senior staff within UK asset management, banking, and insurance.
- In the US, the SEC’s Best Interest regulation enshrines ethics in policy. The proposal attempts to align incentives and outcomes between investors and product providers and their appointed brokers and distributors. Ultimately, it would increase transparency of how fund sellers make their money from product sales, securing that in all instances the needs of the individual investor come before that of the broker or distributor.
- In Japan, the Government Pension Investment Fund (GPIF), the world’s largest pension fund is also taking steps toward ethical advancement. GPIF recently committed to allocating 10% of its entire portfolio, valued at about $100 billion to environmentally and socially responsible investments. GPIF’s move is expected to prompt similar shifts in allocation by other Asian corporate and public pension funds given their considerable influence in the region.
Purpose is a Two-Way Street
There is a discernible shift within the interactions of asset managers, institutional investors, and company executives in recent quarters, with unprecedented philosophical exchange of thoughts about their respective “purpose.” Although most asset managers have long publicly promoted a set of values, some dismissed this as a public relations exercise. Now, investors and firms are holding each other accountable for such statements. Managers are challenging and encouraging companies they engage with to consider risks and incorporate ESG into their business model. In turn, investors are pushing asset managers to ensure that their business models enshrine a sense of purpose, including diversity and inclusion.
It’s become increasingly evident that the measure of success for a global asset manager has moved beyond traditional metrics such as investment returns, risk management, and cost effectiveness. Now, ethical, philosophical, and societal considerations are also on the agenda. Asset managers should look to do good and do well.
“For years shareholder value has been king. Looking after customers, employees and society as a whole has been neglected. That has come back to bite companies,” said Leon Kamhi, head of responsibility at Hermes. It feels like we are at the start of a seismic shift in market expectations in asset management and for the foreseeable future, the only way is ethics.