How are ESG issues impacting the wealth management sector today? What has been achieved so far, what are the opportunities and threats, and what is still to be done?
The current news indicates a clear trend: interest in sustainable investments is growing rapidly, especially sustainable ETFs, which are experiencing an enormous boom in Europe. As a result, 2020 is considered to be a record year for the investment volume in sustainable funds and ETFs.
According to Morningstar, funds that used ESG principles captured $51.1 billion of net new money from investors in 2020 — the fifth consecutive annual record. This was a significant increase from 2019, when investors funneled roughly $21 billion into funds that applied ESG principles.
Furthermore, the fast-growing interest in ESG advice is a good indicator of the relevance of this topic for investors. The number of advisers having ESG-related conversations with customers rose 2 percent to 19 percent between October 2020 and March 2021, according to the latest NextWealth ESG Tracker Study.
Also, investors are increasingly incorporating ESG ratings to evaluate opportunities and risks. As a result, ESG criteria are becoming more relevant for portfolio construction, portfolio analysis, and risk management.
New regulations, such as the Sustainable Finance Disclosure Regulation (SFDR), which came into force across the EU on 10 March 21, are increasing the pressure on financial service providers. SFDR is intended to ensure that those customers that invest in sustainable financial products are well informed by the financial service providers. The obligations arising from this include, for example, the provision of pre-contractual information, information on websites, and regular reporting obligations.
In addition, the EU proposed a regulatory amendment to the suitability test of MiFID II to extend it to include the query of ESG preferences. This is another indicator of the increasing importance of ESG. The suggested amendment seamlessly follows a long series of new regulatory requirements and, in this case, represents a consistent extension of the suitability test.
Nevertheless, the situation with regard to ESG is now different from previous regulatory adjustments. The MiFiD and FIDLEG regulations are focused on protecting the customer; however, from the customer's perspective, their implementation remains non-transparent. Consequently, these regulations are often perceived as more of a bureaucratic burden on both sides, and customers are unable to identify any of the benefits from the regulation!
What's different about ESG?
ESG encompasses environmental and social values that influence customers' willingness to invest and their investment behaviour. For wealth managers, it will therefore be crucial to not only implement the necessary ESG regulatory requirements so they can generate further profit in their investment business but also become active beyond this by increasing their focus on customer benefits and the contemporary concept of sustainability.
ESG, therefore, opens up the following opportunities for wealth managers:
Secure a competitive advantage
Those who position themselves today with an offer that enables investors to invest in values that correspond to their morals or ethics can build a strong position in the market. Moreover, financial service providers who are already one step ahead today and implement solutions that are not yet required by regulation (but are likely to come) benefit from the opportunity to gain an absolute competitive advantage.
Position as a financial coach
Ensuring transparency on ESG issues is not an easy task since it is an entirely new topic, both for the customer and financial service providers. Technological solutions enable financial service providers to introduce customers to this topic step by step, thus offering them a high-quality service. If financial service providers successfully manage to advise their customers professionally – from the initial assessment of preferences, all the way to deriving a suitable recommendation, and finally pointing out the investment's impact – they facilitate the customer's entry into this new topic and thereby prove themselves as a financial coach for the customer. By offering a 360-degree ESG portfolio service (from analysis to reporting), they would not just fulfill their regulatory obligations but would provide an exclusive service to their customers.
Emotionalise the service
There is almost no other topic where emotional values play such an important role as in the field of sustainable investment. ESG criteria pursue goals that have a meaning for the customer. To invest in assets that have an impact on climate change, the protection of the environment, or social injustice is an emotional matter. If the investments or the portfolio represent the customer's values, the outcome is an individual and transparent offer at the highest level.
It is worth noting that with regard to sustainable investments, besides fulfilling regulatory requirements, particular focus should be placed on the customer. After all, sustainability and a sense of responsibility are not only important in the investment business – they reflect the contemporary mindset.
A huge challenge lies in the lack of transparency of sustainable investments. Here, the use of technology at the point of sale enables straightforward and rapid access to a broad range of data providers and rating agencies. Data quality is a critical factor in this respect, so special attention should be paid to select the right provider.
Another challenge is the increasing complexity of investment advice and portfolio construction. While the focus used to be on the portfolio's risk or the individual investment's risk contribution, now numerous additional influencing factors and data have to be taken into account. This complexity can't be solved without technological assistance.
Finally, ESG, which is a new subject for almost everyone, causes significant uncertainty on both the provider and the customer side due to its enormous complexity. Regardless of being an adviser, asset manager, portfolio manager, or customer – everyone is still a "beginner" within this field.
What needs to be done?
Financial service providers should take a proactive approach, take action early and seize the opportunities that this "new" market offers. Even if customers are still hesitant in asking for sustainable investments – one day they will come. By 2022 at the latest, with increasing regulation, ESG investing will be a topic for all investors – institutional and private.
In the next section, you will learn about the opportunities technology offers to reduce complexity and remove uncertainties on the adviser and customer side so that ESG investing in wealth management becomes a sales success.
What solution(s) does your company offer the market that addresses ESG issues, and how do they help wealth management firms manage their increasing obligations in this area?
As a leading technology provider for wealth management and private banking, aixigo always pursues one goal: transforming complex issues to a comprehensible level to ensure an excellent service experience is provided to end customers!*
Also, in the area of ESG, technology offers a range of possibilities to reduce complexity and ensure clarity and trust. In the following, we will show you which solutions aixigo provides in this context and how financial service providers can already benefit from the ESG business today.
These five use cases allow wealth management providers to seize the opportunities of the ESG market and generate new revenues:
Next Level Suitability Check
The suitability test is part of daily business. Alongside the aspects of risk tolerance and experience & knowledge, ESG preferences have to be taken into account, which means going forward, the adviser and customer will have a more comprehensive and emotional conversation. aixigo's software guides both sides towards their goal in a convenient and regulation-compliant manner. This allows both the adviser and the customer to focus entirely on the conversation, the customer's needs, and the customer's goals.
Next Level Portfolio Construction
While portfolio construction was primarily based on risk until now (e.g., Markowitz), the additional inclusion of ESG factors means the emergence of a multi-factor model. Without technological support, portfolio construction now becomes an unsolvable task. "The Portfolio Construction Module" from aixigo's Wealth Management Platform as an API-based solution covers all these factors and thus ensures an efficient and profound portfolio construction.
Besides the portfolio construction, the advisory documentation becomes significantly more extensive due to the consideration of emotional needs. To ensure that the increased effort does not consume additional resources, aixigo's software allows the automated generation of complete and regulation-compliant advisory documentation.
Next Level Monitoring and Rebalancing
Should a number of portfolios be monitored automatically and, if necessary, subjected to rebalancing, the workload will increase significantly if ESG preferences have to be incorporated besides risk. For discretionary portfolio management, this means that both monitoring and rebalancing will become significantly more complex.
aixigo's "Rebalancing and Monitoring Modules" enable the automation of these portfolio management processes. Thanks to the use of state-of-the-art import/data APIs, it is possible to include ESG KPIs from a wide range of data providers or rating agencies without any additional effort. Whether the data is based on MSCI, ISS, or on the customer's request – aixigo's software incorporates all parameters that are relevant for the financial service provider, the regulator, or the customer. This ensures a high-quality portfolio management service for financial service providers and customers. The outcome of this automation is an efficient process and the creation of a scalable portfolio management business.
Next Level Reporting
Up to now, high-quality reporting has comprised key figures such as volatility, returns, risk ratios, or similar metrics. With ESG, various complex information and data will be added that have to be gathered from multiple databases and interfaces and be prepared for reporting in a comprehensible manner.
With aixigo's "Reporting Module", all these requirements can be met, and further data fields can be added to the report. In combination with aixigo's "Analytics Module", it is possible to provide the customer with a report on their ESG Footprint, making their ESG engagement tangible. Figure 1 shows which information will be displayed to the customer within the ESG Footprint. The customer can recognise the impact of his investments on the specific ESG criteria.
In addition, the customer is provided with information on investments that suit their goals, as well as which investments should be critically checked with regard to alternatives.
aixigo's "Analytics Module" offers an easy-to-integrate API so that the portfolio analytics can be easily displayed in different applications in a multi-channel approach.
aixigo AG, application screen “ESG footprint”
aixigo AG, application screen “Timeline Module”
News Feed Impact Investing
In addition to returns, customers interested in ESG have a strong interest in social or environmental issues and typically want to make a difference with their investments. Using our "Timeline Module", a customised newsfeed can be generated for the customer. The newsfeed displays either generally accessible data or curated content on the impact of the recommended products.
It is important to note that there is a set of requirements to be considered by financial service providers to professionally implement ESG requirements, which require automation and software-based support.
Christian Friedrich, CBO aixigo, commented, "If financial services providers take ESG seriously and rely on technological solutions to do so, the adjustments at the point of sale may be greater than expected. It will not only be a matter of adding a few extra data fields – rather, with impact investing, thematic investing, and ESG investing, we will experience a new evolutionary stage in investment advice."
To sum up, there are many opportunities arising from ESG for wealth mangers to position themselves as an expert in this area. If financial service providers take this chance, they will gain a competitive advantage, prove their expertise, and increase their profits!
Why aixigo?
aixigo's API-based wealth management platform provides customised solutions for financial service providers. Financial service providers can select from over 100 different modules and microservices to reach higher process efficiency right where they need it. The integration can be done fast and easily, meaning it is not too late to build a strong position in the new ESG market for financial service providers.
*You can read more on how aixigo succeeds in reducing complexity in our recent Thought Paper “Disrupt Financial Planning – How Financial Planning becomes a 365-day service“. Access it by clicking on the following link: https:// bit.ly/3hOjxS1
This article was originally part of our Wealth Tech Views ESG Report. Click here to access the full report.
