If you don’t invest in RISK MANAGEMENT, it doesn’t matter what business you’re in, it’s a risky business.
GARY David COHN (2011)
Environmental risk can be defined as risks arising from the potential adverse impact of changes in the environment stemming from economic activities of human beings. It can take the form of any source of harm or danger in the environment ranging from climate change, pollution, loss of biodiversity, to depletion of natural resources. Environmental Risk Management (ENRM) is an increasingly important consideration for fund management companies. As investors become more aware of the environmental impact of their investments, fund management companies need to take steps to identify, assess and manage environmental risks.
The Task Force on Climate-related Financial Disclosures (“TCFD”) classifies environmental risks as physical risks and transition risks. Physical risks are associated with physical impacts of climate change while transition risks relate to the risks involved when transitioning to a lower-carbon economy. Although not all environmental risks are climate-related, climate change is widely seen as the most severe environmental risk with steadily rising temperatures and alarming global projections that will result in future irreversible damage.
The industry has become accustomed to the term “ESG” which refers to investment prioritizing favorable environmental, social and governance factors or outcomes. Investors have developed an increasing awareness of environmental risk and look to ESG investing as a reflection of their understanding that the financial performance of organizations is increasingly being affected by, and is affecting, environmental and social factors. Inevitably, environmental factors have become a key consideration for investors looking to make more sustainable decisions. Accordingly, governments and policymakers are playing their part to transition to a more sustainable economy through the creation and implementation of green policies. In turn, this has spurred fund managers to comply with environmental policies and strive to meet the demand for sustainable investment opportunities
What Are the Types of Environmental Risks?
Environmental risks can take many forms, including physical risks such as natural disasters and climate change, regulatory risk arising from changing environmental regulations, and reputational risks arising from poor environmental practices. These risks can have a significant impact on the value of investments and failure to manage them effectively can result in significant financial losses. Environmental risk has the potential to financially impact funds/mandates managed by asset managers through physical, transition and reputational risk.
Physical risk arises from the impact of weather events and long-term or widespread environmental changes. For instance, rising frequency and severity of extreme weather events can impair the value of assets held by companies, or indirectly impact supply chains, thus affecting companies’ operations and profitability, and potentially, their viability. Water risk (e.g. water scarcity, pollution and droughts) may increase the operating cost of companies in water-intensive sectors. Investments into these companies can therefore be impaired.
Transition risk arises from the process of adjustment to an environmentally sustainable economy, including changes in public policies, disruptive technological developments, and shifts in consumer and investor preferences. For instance, the transition to a low-carbon economy can impair the profitability of companies in carbon-intensive businesses. Punitive actions taken against companies that pollute the environment, This can have a material impact on the valuation of companies in these sectors and result in stranded assets. Investment portfolios managed by asset managers may also be exposed to volatility and downside risk where business models are disrupted by changes in market or consumer demands to address environmental impact.
Reputational risk can arise when asset managers invest into companies that carry out business activities which have a negative impact on the environment. Negative perception of asset managers’ business practices can adversely affect their ability to maintain or grow their assets under management.
What Singapore Fund Managers Need to Know – Key Aspects
Fund Management Companies are expected to display their implementation of the ENRM guidelines in a manner that is commensurate with the size and nature of the company’s activities, including the investment focus and strategy of its funds/mandates. To manage environmental risks, fund management companies need to develop a comprehensive environmental risk management strategy. This strategy should include the following key steps:
- Identify and assess environmental risks: The first step is to identify all the potential environmental risks that could affect the fund’s investments. This can be done by conducting a thorough environmental risk assessment that considers the physical, regulatory, and reputational risks associated with each investment.
- Develop an environmental risk management plan: Once the environmental risks have been identified, the fund management company should develop an environmental risk management plan that outlines the strategies and actions that will be taken to mitigate those risks. This plan should be regularly reviewed and updated to ensure that it remains effective.
- Implement environmental risk management measures: The next step is to implement the environmental risk management measures outlined in the plan. This could involve investing in companies that have strong environmental risk management practices, avoiding investments in high-risk industries, or engaging with companies to encourage them to adopt more sustainable practices.
- Monitor and report on environmental risks: Finally, Singapore fund management companies should monitor and report on environmental risks to ensure that the environmental risk management plan is effective and to identify any new or emerging risks that may need to be addressed
We’re UNDEFEATED in regulation.
Les miles
MAS’ Expectation
The ENRM Guidelines spells out MAS’ expectations for Singapore fund management companies to integrate environmental considerations into its business in the following main areas: https://www.mas.gov.sg/publications/monographs-or-information-paper/2022/information-papers-on-environmental-risk-management
- Governance and Strategy
- Research and Portfolio Construction
- Portfolio Risk Management
- Stewardship and Disclosure
1. Governance and strategy
The regulatory expectation: The ENRM Guidelines expects Singapore fund management companies to put in place a corporate governance structure and strategy that will facilitate the integration of environmental risks into the fund management company’s risk management framework. Fund management companies should identify, address and monitor material environmental risks in a manner commensurate with its nature, scale and complexity.
How this can be done:
- Allocating clear roles and responsibilities for environmental risk – the Board of Directors and Senior Management should have an effective oversight of the fund management company’s environmental risk management and disclosure.
- Ensuring that the company’s management has adequate expertise and resources to deal with environmental risk management.
- Developing and implementing an environmental risk management framework, policies and processes – this may include the use of tools and metrics to monitor the fund management company’s exposure to environmental risk.
- Articulating strategies that deliberately consider the management of environmental risks in the fund management company’s own operations and the funds/mandates managed – this may include the use of clear quantitative metrics and interim targets.
Larger fund management companies may put in place comprehensive governance structures that comprise of dedicated individuals or functions supporting the Board’s oversight of environmental risk. Alternatively, smaller fund management companies would be better suited by integrating those environmental risk-related roles or functions within existing structures to optimise the use of its resources.
2. Research and Portfolio Construction
The regulatory expectation: Fund management companies are expected to embed relevant and material environmental risk considerations in their research and portfolio construction processes. Additionally, fund management companies should actively track and manage the environmental risk factors present in a fund/mandate on an aggregate basis.
How this can be done:
- Fund management companies should identify and assess environmental risk at the asset and/or portfolio level while considering both physical and transition risks across asset classes.
- Sectors with higher environmental risk should be identified by risk criteria (e.g. GHG emissions and linkages to unsustainable energy practices, deforestation and pollution).
- The approach to high-risk sectors should be defined – this could take into account internationally recognised sustainability standards and frameworks (e.g. the Global Reporting Initiative, CDP’s Global Disclosure System, Sustainability Accounting Standards Board (“SASB”) ESG Report Framework and TCFD’s Framework).
- Being mindful of internal aggregate limits set by customers for specific sectors of types of activities.
Fund management companies should obtain the necessary environmental data through reliable sources to be used in their environmental risk assessment. Additionally, fund management companies may develop a methodology for proprietary risk ratings or seek to use the ratings of a ratings provider in identifying high-risk sectors. The framework adopted for assessing environmental risk should be relevant to the fund management company’s business and investment strategy.
3. Portfolio Risk Management
The regulatory expectation: Fund management companies are expected to monitor, assess and manage the material potential and actual impacts of environmental risk on both individual investments and portfolios on an ongoing basis.
How this can be done:
- Ongoing monitoring of the portfolio’s environmental risk should be conducted – this includes processes for re-assessment of risk and escalation of material environmental risk exposures.
- Scenario analysis capabilities should be developed as a tool to assess the impact of environmental risks on portfolios.
- Capacity building programmes should be conducted to equip staff with adequate expertise to assess, manage and monitor environmental risk.
Environmental risk-related data should be periodically reviewed and risk ratings should be kept up to date. Roles for environmental risk monitoring may be allocated to compliance teams to track compliance with the fund management company’s environmental commitments. Fund management companies should also be aware of and monitor any risk of greenwashing.
4. Stewardship and Disclosure
The regulatory expectation: Fund management companies are expected to shape the corporate behaviour of investee companies through engagement and disclose environmental risk management approaches to stakeholders.
How this can be done:
- Engagement, proxy voting and sector collaboration to support the transition to more sustainable policies and practices over time.
- Management should determine the appropriate stewardship approach to be adopted by the Fund Management Company
- Fund Management Companies should refer to international reporting frameworks like the TCFD Recommendations when preparing disclosures.
Fund management companies are encouraged to clearly communicate their approach to stewardship in supporting the transition of investee companies towards more sustainable policies and practices. This can be achieved through various engagement methods with selected investee companies, taking into account their exposure to environmental risks. Additionally, fund management companies should closely monitor the form and frequency of disclosures, ensuring compliance with internationally recognized reporting frameworks such as the TCFD’s recommendations. Disclosures should also be assessed and reviewed annually to include updates and improvements.
How can Curia Regis assist you?
Our experienced team can provide a comprehensive overview of the key areas for fund management focus. This can be done by ensuring adequate and efficient integration of environmental risks into the company’s risk management framework. We strive to comprehend your business thoroughly and assist you in creating a customized strategy for handling environmental risk..
In Summary
Effective environmental risk management requires a collaborative approach that involves all stakeholders, including investors, fund managers, and investee companies. Investors increasingly expect fund management companies to take environmental risks into account when making investment decisions. Failing to do so can result in reputational damage and loss of clients.
All things considered; effective environmental risk management is essential consideration for fund management companies in today’s market. By identifying and managing environmental risks, fund management companies are able to protect the interests of their clients. In addition, to also ensure that their investments are sustainable over the long term. Being proactive towards ENRM, fund management companies can be responsible market players who are committed to sustainable investing practices.
Risk comes from not knowing what you’re doing.
“The Three Essential Warren Buffett Quotes To Live By” by James Berman,2014″
