A disruptive cultural shift is driving change in the financial industry. Investors and new sources of deals are redesigning the fundamentals of the asset management business.In the asset management sector, trends have generally evolved to keep pace with the need to identify new ways of delivering alpha, as investors have traditionally been focused mainly on return. Today, however, investors are increasingly concerned with the social impact of their investments.
The communication on the European Green Deal recently issued by the European Commission is representative of this changing environment. Indeed, the EU aims to become climate neutral by 2050. On a more global scale, similar sentiments were voiced at the last UN Climate Change Conference (COP 25) in Madrid. Initiatives at the European and national levels focusing specifically on the financial industry are also being taken, such as Regulation (EU) 2019/2088 on sustainability‐related disclosures in the financial services sector. In the Grand Duchy of Luxembourg, there is already a legal framework for green covered bonds linked to renewable energy projects; in addition, a new bill (no. 7433) on sustainable finance aims to introduce more favourable rules for inter alia funds with environmental, social and governance (“ESG”), green or similar investment strategies. Finally, the Luxembourg Stock Exchange has issued guidelines for reporting on ESG aspects that address “the specific scope and needs of its three main stakeholders: companies, issuers of sustainable debt instruments, and asset managers active in sustainable & responsible investment funds”.
The real economy is influencing the financial economy and forcing portfolio managers to develop products that are more in line with investors’ expectations. Unless they have a positive impact on, for example, the environment, the healthcare system or access to affordable housing, strategies will not be considered in line with current trends, regardless of whether they take a short or long approach, relate to a correlated or uncorrelated investment approach or public or private debt.
There is indeed growing demand for the industry to participate in resolving questions and respond to real-life needs.
ESG investing takes into account both ethical factors and financial elements in the decision-making process and has become increasingly common worldwide in recent years. Once a niche approach thought to come at the expense of returns, such strategies have proven that they can be market-beating. As ESG momentum builds, it is argued that companies can no longer afford to ignore ESG ratings. Last year, record amounts were invested in so-called sustainable funds.
Within the overarching category of sustainable investing, strategies include ESG integration, socially responsible investing and impact investing. In brief, the primary factor in ESG integration is still financial performance, while impact investing is meant to maximise, with a quantifiable impact, social reach. Socially responsible investing can be considered to fall somewhere in the middle.
The first priority for ESG integration strategies remains financial performance, while impact investing focuses on achieving the greatest possible social reach.
Performance measurement is coming under increasing scrutiny by investors, and asset management firms need to be able to report on financial and social results in a transparent manner.
In the financial sector, digital transformation tops the list of priorities of a majority of financial institutions and actors. The integration of digital technologies into all areas of business, including human resources and finance, entails a cultural shift and requires organisations to constantly question themselves and the way they operate and deliver value to customers.
In practice, we may expect increasing adoption of digital operating models, including integrated cross-functional teams, better use of artificial intelligence and machine-learning processes, greater reliance on the public cloud, encompassing a more detailed legal and regulatory framework, and finally continuous investment in data storage in order to synthesise data and facilitate their use.
Luxembourg, the frontrunner in anticipating and driving change
The Luxembourg financial sector is already investing in new standards and processes and revamping its service offering in order to adapt to the rapidly changing landscape. One of the keys to the success of the Luxembourg financial sector is the speed at which participants (i.e. service providers, credit institutions, auditors, lawyers and authorities) invest in and purchase new skills and technologies to ensure they are seen as modern, mature and competent business partners by the international markets.
As has been the case in the past for other strategies, knowledge and expertise in new areas of investment and services, to anticipate and drive change, will enable the Grand Duchy to remain a location of choice for investors and asset managers.
Law firms need to consider all aspects of digital transformation as well as ESG issues and impact-investing asset classes and understand the various components and models in order to be able to assess them adequately in the due diligence process and ensure that they are reflected in contractual and legal documentation.
As global front-runners, Luxembourg financial sector players have not only an opportunity but also a duty to stay on top of these trends. Understanding ESG and digital transformation entails implementing appropriate processes within each organisation and constantly innovating by adopting an open-minded, ESG-oriented approach in all areas of business.