When a trend showcases continued value extending into the future, then the trend in question becomes a norm. Such is the case with sustainable investing, or “ESG investing”, as the term has evolved and used within the financial sector: The infrastructure, mechanism and consumer demands developing around it project that it is here to stay.

What is ESG?

ESG is an umbrella term for a broad range of environmental, social and governance factors against which investors can assess the behavior of the entities they are considering for investment. The environmental aspect of ESG is a measure of a company’s impact on the natural environment. It takes into account factors including its carbon footprint, its impact on biodiversity and its production of wastes and pollution. The social aspect measures how a company treats people such as employees, customers and the communities in which it operates, while the governance aspect measures how a company operates in terms of audits, board diversity, internal controls and shareholder rights. These factors enable investors and other stakeholders to measure the performance and ensure the accountability of companies. Hence, one crucial aspect of ESG is that it is not simply about seeking compliance with current regulations but rather, it focuses on the potential for a company to have a more positive impact alongside seeking to make a financial return.

How has ESG become important?

ESG's rise in importance has been driven by a number of key factors. First, there has been a rise in public concern for environment and social equity. This has been reflected in an increasing desire to see that investments are ethically placed. Millennial investors, for instance, are more likely to invest in companies targeting social or environmental goals. Moreover, the growth of the ESG agenda has been influenced by a number of key organisations and regulator drivers, including the UN Principles for Responsible Investment (UNPRI) and the package of EU sustainable Regulations which seeks to integrate ESG considerations into the investment and advisory process in a consistent manner across sectors. Last but not least, and simply put, the driver amongst many people working in the sector to simply do the right thing.

ESG in the context of the Fund Industry

Given the substantial attention towards sustainability and its relative immaturity as an investment trend, ESG is having a fast-growing impact on the investment funds sector on a worldwide basis. At a national level, and in light of the newly enforced Sustainable Finance Disclosures Regulation (EU) 2019/2088 (“SFDR” or “Disclosure Regulation”), the Cyprus Securities and Exchange Commission (“CySEC”) has recently reinstated in a recent announcement its commitment and focus to fostering compliance with sustainable finance standards. The Disclosure Regulation has imposed harmonised transparency and disclosure requirements on financial market participants and financial advisers and requires firms within scope to consider how sustainability risks are incorporated into the investment decision-making process and even how the remuneration of individuals is consistent with sustainability issues. As such, the SFDR is expected to affect a large proportion of the financial services industry in Cyprus.  CySEC has clarified that supervised entities must ensure full compliance with the SFDR disclosure obligations and with their ESG responsibilities in general and will closely monitoring firms and take appropriate action where relevant to prevent mislabelling, misrepresenting or misselling in relation to sustainable finance to protect consumers and prevent them from being misled.

While the ESG funds constitute a tiny part of the global stock market as we speak, the path towards sustainable finance is apparent and calls for all asset managers to become more focused in ensuring the inclusion of social and environmental considerations in decision-making processes. In the context of the fund industry, investment funds may have to consider and potentially make internal strategic changes about how they operate their business in order to align their practices with the new regulatory requirements revolving around ESG. There is a broader opinion that soon, sustainable investing will just be called investing. One could therefore conclude that the winners will be those companies that will continue to demonstrate strong leadership and dynamic strategy to make material changes to their environmental, social and governance practices.  

By Nicole Kallasides, Legal Advisor at Cyprus Investment Funds Association