How Risk and Compliance functions can support the net zero transition: Investment Managers and net zero

At a glance:

• Many investment managers have made commitments to reach net zero greenhouse gas (GHG) emissions by 2050 amid growing stakeholder expectations that they will develop, disclose and execute credible transition plans.
• Meeting these commitments will require investment managers to transform their entire organisation across their business strategy, products and services, investment decision-making, risk management, and operations
• Risk and Compliance functions, working with colleagues from across the organisation, have an important role in supporting the design and execution of the transition plan.
• We have published a report in collaboration with the Investment Association: How Risk and Compliance can support the transition to net zero: Investment managers and net zero, which considers regulatory developments and actions for Risk and Compliance functions in relation to the net zero transition.
• This blog summarises the key themes discussed in the report: (i) credible net zero plans; (ii) governance, culture, and incentives; (iii) climate risk management; (iv) greenwashing; (v) treatment of customers; and (vi) thinking about ESG holistically.

To mitigate the worst effects of climate change, action is needed now. The financial services industry has a crucial role to play, and investment managers are in a unique position to help channel investments to sustainable activities. Many investment managers have joined Governments and other corporates and financial services firms in making commitments to reach net zero GHG emissions by 2050.

Since COP26, regulatory expectations in relation to transition plans have evolved rapidly. To facilitate net zero commitments, regulators, supervisors, and wider stakeholders increasingly expect investment managers to develop, disclose and execute credible transition plans.

This means new responsibilities for staff at investment managers, including Boards, senior managers, and across the three lines of defence. As part of this, Risk and Compliance functions will have an important role to play, particularly in relation to mitigating the reputational, conduct, regulatory and liability risks that may arise from failing to deliver against transition plan targets, poor plans, or poor disclosures.

To support Risk and Compliance in this role, we have published a report in collaboration with the Investment Association: How Risk and Compliance can support the transition to net zero: Investment managers and net zero. The joint report considers regulatory developments in relation to net zero transition plans and sets out actions that Risk and Compliance functions can take to facilitate their development and execution.

This blog summarises the main themes in the report.

1. Credible net zero plans

The credibility and business implications of transition plans will face increasing supervisory and stakeholder scrutiny.

Risk and/or Compliance can advise the wider firm on regulations, expectations and guidance on transition plans and engage actively with policymakers, regulators, standard-setters, and industry bodies. They will need to support the development of the transition plan and create policies, procedures, and controls to monitor ongoing adherence to the plan and escalate concerns proactively.

2. Governance, culture, and incentives

Robust governance, with an aligned culture and incentives, will be essential in facilitating the execution of net zero plans. There should be a clear sense of purpose and alignment across the transition plan, climate strategy, business strategy, product range, risk appetite, risk management, culture, and incentives. Firms’ governance structures and culture should be effective in cascading the transition strategy and plan horizontally and vertically throughout the firm, with responsibilities allocated clearly across the three lines of defence.

The Chief Risk Officer and Chief Compliance Officer should have a seat on relevant Committees, to give them a voice in developing the transition plan, and in providing second line oversight on adherence to the plan. Risk and/or Compliance should provide the Board and relevant Committees (e.g., the Risk Committee, Risk and Compliance Committee, and Investment Committee) with robust management information (MI) on the delivery of net zero plans and performance against KPIs, metrics and targets.

3. Climate risk management

Investment managers are required to manage and/or disclose their risks which arise from climate change, for example, under the Financial Conduct Authority’s Taskforce for Climate-related Financial Disclosures-aligned rules and the EU Sustainable Finance Disclosures Regulation (SFDR). A credible transition plan will help investment managers with their work on climate risk management by reducing exposure to transition, liability, litigation, and reputational risks. Investment managers can also leverage their existing risk management frameworks to support the net zero transition.

Risk and/or Compliance should identify and integrate climate risks into the risk management framework and ensure the strategy on climate risk management is aligned with the transition plan. It will also be important to identify and address gaps in knowledge, skills and experience on climate change and related risks within their own teams.

4. Greenwashing

Greenwashing is high on regulatory agendas, with regulators around the globe carrying out regulatory enforcement in this area. Greenwashing is often seen as a deliberate act of misconduct. However, when faced with incomplete ESG data and unfamiliar terminology, investment managers also need to address the risk of greenwashing inadvertently.

To support the net zero transition and reduce liability, litigation and reputational risks, investment managers should ensure accurate and compliant disclosures on net zero transition plans, firm-wide climate policies, emissions, and products.

Disclosures will need to be underpinned by a robust climate data strategy, data governance and target operating model and Risk and/or Compliance can support the firm as these are developed.

Risk and/or Compliance should also leverage existing control frameworks to ensure that there are processes, policies, and controls in place to monitor funds which promote or target climate characteristics across the product lifecycle.

5. Treatment of customers

Investment managers have a pivotal role in supporting their institutional clients and retail customers with their climate ambitions and/or preferences.

Risk and/or Compliance should verify that customers are treated fairly as investment managers’ product offering changes. They should ensure that climate considerations are incorporated into product governance, where required. A thorough investigative procedure around complaints handling, particularly in relation to greenwashing claims, will also be a good indication of customers concerns are taken seriously by the firm.

6. Thinking about ESG holistically

As there are more funds which promote or target sustainable or ESG characteristics than solely climate characteristics and many regulatory requirements or supervisory expectations include broader environmental or ESG considerations in their scope, investment managers will need to think about ESG holistically.
Risk and/or Compliance should consider how to integrate nature considerations into the risk management framework, product range, and investment decision-making processes. They should also ensure that fund documentation and client disclosures are clear on how they will treat trade-offs between “E”, “S” and “G”.

Conclusion

Meeting net zero commitments will require a transition to a fundamentally different and more sustainable economy.

With the recent findings of the Intergovernmental Panel on Climate Change that we have a “brief and rapidly closing window to secure a liveable future”1, the impetus for investment managers, as stewards of investor capital, to move from ambition to action is more urgent than ever before.

Investment managers will need to transform their entire organisation across their business strategy, products and services, investment decision-making, risk management, and operations.

Alongside the Board, senior managers and those in the business and internal audit, Risk and Compliance functions can play an important role in supporting their firm’s net zero transition and ensuring their firm is positioned for the future in terms of competitiveness and resilience.

Please see our report for further details.

¹Climate Change 2022: Impacts, Adaption and Vulnerability, IPCC, February 2022.