ESG regulatory scrutiny expected to slow ETF development

The growth of environmental, social and governance-focused exchange traded funds is set to encounter difficulties as a result of increased regulatory scrutiny, leading industry figures have warned.

Marie Coady, global ETF leader and partner at PwC Ireland, told Ignites Europe she believed it would take time for index providers and managers to “work their way” through ESG regulations in terms of “rebalancing the index and closing the data gap”.

Andrea Murray, head of business development at Blackwater Search and Advisory, said the growth of ESG ETFs faced challenges as regulatory scrutiny began to “make an impact” on the product development process.

Murray added that there would be “potential delays or redesigns of product ideas” as regulatory changes within the market “make an impact” on the product development process.

“If stricter ratings drop a product to a much lower rating, it may not be appealing to institutional clients, which are the largest and most impactful investor base in Europe,” she said.

This article was previously published by Ignites Europe, a title owned by the FT Group.

That could have a meaningful effect on ETF investment in Europe. In 2022, ESG ETFs accounted for 65 per cent of inflows into European ETFs, according to Morningstar.

Regulators have been on a drive to stamp out “greenwashing” by defining and labelling ESG investing. In a recent example of the increasing pressure on index and fund providers, changes to MSCI ESG ratings are expected to result in hundreds of funds being stripped of their ESG rating.

Asset managers will not waste time creating the products if they cannot solve a client problem or investment need, Murray said. “This can certainly introduce barriers to entry for new ESG ETF products,” she added.

But she pointed out that the ETF industry and the people within it are “resilient” and “can find a way to circumnavigate changes”.

“I don’t see the doors to new ESG products being fully locked anytime soon,” she added.

Manooj Mistry, chief operating officer of HANetf, said he expected ESG ETFs to continue to be launched as “the demand is there”.

Coady said regulatory changes were not going to have an impact on growth in ESG ETFs because “investors are committed to ETFs”.

She said “a powerful and deepened partnership relationship” between the index provider and the asset manager was needed because each was dependent on the other.

“The partnership has to find out how to deliver the information to construct the index and achieve the outcome that supports investors’ sustainability goals,” she said. “It will require managers to be more innovative and a huge amount of diligence.”

Hermin Hologan, wealth and asset management leader at EY for Europe, Middle East, India and Africa, said: “While the ratings are useful for investors in their investment process, with the ongoing scrutiny of the ratings, investors may become less focused on the end rating, and perform enhanced due diligence on the components of the end product.”