Custodians have an important role to play in ensuring investors can achieve their sustainability goals.
As sustainability becomes an increasingly mainstream investment theme, many investors are no longer viewing opportunities purely through the lens of expected returns. They are also looking to protect the environment, help society, and promote high standards of corporate governance.
Up until now, much of the work done by the financial community that is guided by these so-called ESG principles relates to directing funds towards, or away from, relevant investment opportunities and identifying ESG-related financial risks. With the global value of professionally managed sustainable assets now over USD40 trillion1, we are at a point where the industry is moving beyond asset allocation to how such a large amount of assets is overseen. This creates an emerging role for custodian banks.
The best way to see how a custodian bank can contribute to sustainability is by first considering one its core traditional functions – the daily calculation of a fund’s net asset value. The custodian provides this key performance metric, taking over a routine function that the fund would otherwise have to do itself. And as the custodian is an institution independent of the fund, the figure is considered both accurate and trustworthy by the fund’s investors.
The new focus on ESG takes the authority and independence that allows a custodian bank to provide NAVs and provides an opportunity to provide additional reporting of ESG attributes of a portfolio of assets.
Although many funds currently conduct this work themselves, it is by no means a simple process, and it makes sense for this kind of reporting to be outsourced to a specialist provider. At the same time, the clients of asset managers could benefit from third-party ESG reporting about the funds they invest. Such independent reporting could help endorse the ESG credentials of a fund, and to allay any concerns about the risk of greenwashing – using misleading claims that exaggerates how sustainable a product is for end-investors.
In an ideal world, sustainability reporting on assets will become just as much a key part of a custodian bank’s offering as safekeeping assets and the day-to-day calculation of NAV. That would be a sign that ESG considerations are an orthodox part of financial services reporting to investors. We are a long way from achieving such a goal, but it is one that we can work towards by addressing the key challenges facing this nascent area for securities services providers.
More art than science
Once again, we can understand the issues associated with assessing sustainability within a pool of assets by comparing it with calculating NAV. When a custodian or administrator generates an NAV for a fund, it uses data that is consistent across all information providers – namely, prices at the close of trading. It then uses an industry standard methodology to generate the final figure. It is a purely quantitative process that is relatively straightforward to complete.
When it comes to reporting on ESG rating of a fund’s assets, the situation is a lot more complicated. For a start, there is the issue of data. In terms of availability, there is significant variety in what different countries require of listed companies to disclose. In addition, privately sourced data can vary from one provider to another. And to make things even more challenging, there is no standard method for measuring sustainability among assets – some investors for example, might value governance factors over environmental ones. Taken together, all these factors demonstrate that reporting on asset sustainability is just as much art as it is science, and in its current state is very much qualitative in nature.
Does this mean that efforts by custodian banks to provide sustainability reporting are futile? Absolutely not. At HSBC Securities Services, we recently launched a reporting service that can evaluate a portfolio of assets according to three of the most recognised suppliers of ESG scores and ratings plus carbon emissions, thus allowing asset managers and owners to have transparency over the differing ESG data and to find the rating system that aligns most with their values.
We think this is a very credible solution in a situation where there is no single way of measuring sustainability, as it provides a very accessible and cost-effective level of transparency. It measures a fund’s ESG performance, providing the means to challenge asset managers about investments that are rated poorly, according to each of the three providers.
A sustainable future
We are still only at the early stages of custodian banking’s sustainability journey. But it is important to be involved now, because there is no time to waste waiting for standardised ESG data to become established. It means that we can travel together with funds and asset managers to develop reporting tools that evolve with their needs.
Although there are different ways to measure a portfolio’s sustainability, it is likely that the financial industry will hone in on a smaller number of approaches, ideally whittling the selection down to a few commonly accepted and standardised ESG measurements. Much of this will be directed by policymakers.
In Asia for example, regulators in the regional finance hubs Hong Kong and Singapore are both consulting on ESG regulations. But custodian banks active in this space will also play a role, as their experience dealing with multiple methodologies will provide valuable insight into how ESG can be integrated most meaningfully into custodian services.
What we can be sure about is that ESG is here to stay, and it is theme that will play out over the coming decades. At the highest strategic level, HSBC has made sustainability a top priority, with a commitment to become net carbon neutral by 2050. This means that every part of the bank needs to step up – corporate banking will issue more green loans and investment banking will champion sustainable investments. Our job as a custodian will be to ensure that investors can readily assess insights into ESG risks and opportunities as well as the positive impact their investments are making.