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November 7, 2022

ETF providers wake up to the baseline demands of climate risk

Slow to engage, this year’s ETF Stewardship Survey from Sage Advisory indicates providers now recognise the dangers of greenwashing.

By Adrian Murdoch

ETF, Stewardship, Climate, Sage Advisory
Larry Fink, chairman and CEO of BlackRock, has been criticised for playing both sides of the climate debate raging in the US. (Photo by Erik McGregor/LightRocket via Getty Images)
  • At the end of last year, the ETF market globally held $10.1trn in assets.
  • 78% of respondents to Sage Advisory’s survey said that they have established guiding principles for climate risk assessment.
  • TCFD standards have become the guiding principles for climate risk assessment for ETF providers.

In Shakespeare’s As You Like It, the English playwright characterises the whining schoolboy with his satchel “creeping like a snail unwillingly to school”.

It is hard not to keep this imagery in mind when looking at the responses of exchange-traded funds (ETF) to this year’s ETF Stewardship Survey from Austin, Texas-based investment management firm Sage Advisory, which appeared in late September.

In what is now the fourth year of the survey, which looks at how well ETF providers perform their fiduciary duty on behalf of their investors, there is a sense that ETF managers have finally realised that good governance and sustainability are not going to go away. There appears also to be growing recognition that they might now be held accountable for any extravagant green claims they make publicly.

More ETF providers than ever bit the bullet and engaged with the Sage Advisory questions. This year, 23 ETF providers took part in the survey – up from 17 last year – with $37trn assets under management (AUM).

As well as major players like BlackRock, State Street Global Advisors, Pimco and DWS, laggards like California-based Franklin Templeton and Vanguard finally took part this year.

That Vanguard has decided to play ball is significant. Although the Pennsylvania-based asset manager ($7.2trn AUM) did take part in 2020, it did not do so last year. Re-engaging is a sign it realises transparency is a key component of stewardship.

Influence? Yes. Influential? No.

Often overlooked, the weight of the ETF market should not be underestimated. At the end of last year, the ETF market globally held $10.1trn in assets and there has been little slowdown in inflows.

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The US market – which makes up 71% of the global total – had attracted just under $500bn new money until the end of October this year, according to the Investment Company Institute, a Washington DC-based global association of regulated funds.

The attraction to investors of ETFs is undeniable. They offer easy diversification, access and liquidity. In early September, Bloomberg estimated shares in S&P 500 companies held by passive investment vehicles could be as high as 37.8%.

On the flip side, ETFs do not give true ownership rights in that investors in them do not have the right to vote on shareholder issues, but there are some signs of change.

Inspired by what chief executive Larry Fink last week called in an open letter to clients the “public debate around issues that can impact the value of companies”, BlackRock announced a trial to allow retail investors to engage in proxy voting.

But for the most part, all rights of engagement remain with the ETF fund managers and the sector’s relationship with sustainability has been loose at best.

Despite an uptick in respondents, the survey complains about the decline in their overall transparency and disclosure scores. Only just over three-quarters (78%), for example, attached their voting records with their completed survey questionnaires, something it says will be requested by the survey next year.

Loose lips sink ships

More to the point, it says that almost half (47%) of repeat respondents received a lower transparency score as compared to last year specifically about voting and engagement strategies.

However, Sage Advisory interprets this as concern about regulation. “Regulators in the US and abroad are cracking down on potential greenwashing by handing out fines to those asset managers who are found to be overselling their ESG credentials,” it concludes.

While figures are in decline this year, Bob Smith, president of Sage Advisory, thinks that it is positive going forward. It will lead to less greenwashing and managers are likely to “err on the side of caution”, he said, when talking about their ESG credentials.

Measuring climate risk

That this cup is half full is boosted by the importance that ETF providers place on measuring climate risk – the first time that the question has been asked.

Almost four-fifths (78%) of respondents said that they have established guiding principles for climate risk assessment, with the figures being driven by publicly owned firms.

And there are signs of harmonisation. The Task Force on Climate-related Financial Disclosures (TCFD) standards, rapidly becoming the guiding principles for climate risk assessment, are followed by 70% of firms in the survey.

The report calls the TCFD standards “a pathway” to incorporate climate risks and opportunities into the investment process and says that it expects them to “keep picking up momentum” for next year.

There is a long way to go, of course, and it would be naïve to expect ETF providers to hop, skip and jump towards greater disclosure, but at least there are signs that they are no longer creeping like snails.

Are ETF providers avoiding Scope 3 reporting?

The websites of ETF providers might have pictures of waterfalls and alpine scenes front and centre, but the reality does not match the image.

The firms are happy to report their own Scope 1 and 2 emissions. Like other office-based organisations, these are typically small and it is easy to show huge declines.

In July this year, BlackRock ($10trn AUM), for example, was able to report a 20% decline in Scope 1 and 2 emissions on last year.

But they are much less enthusiastic about coming clean on Scope 3 emissions – activities from assets not owned or controlled by the reporting organisation. In other words, their investments.

Responding to an October survey from Morningstar, a third of respondents, including BlackRock and Vanguard, suggested that Scope 3 emissions disclosures should remain limited or deferred.

Not really a surprise. As Capital Monitor reported in July, Vanguard is the largest single shareholder in six of the top ten listed companies globally with the largest carbon footprints: BP, Chevron, Exxon Mobil, Saudi Aramco, Shell and Volkswagen.

And Vanguard is not remotely an exception. London-based non-government organisation Reclaim Finance, ranked 30 major asset managers on their climate commitments in April and found that they hold $468bn in 12 major oil and gas companies, much of it via their ETF funds.

Reclaim Finance’s sustainable investments campaigner Lara Cuvelier accused the asset managers of “kicking the can down the road without even asking companies to stop worsening the climate crisis”.

Kicking the can they may well be doing, but much like the reluctant schoolboy, they are at least heading in the right direction while doing it.

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