Attorney Authored

Impact Investing: Compliance and Legal Considerations for Asset Managers

February 04, 2020

Vadim Avdeychik

Whether you call it ESG, SRI, Responsible Investing, or Impact Investing, investing with a purpose for a better tomorrow has attracted the attention of many investors. The Global Impact Investing Network recently reported the size of the market at USD 502 billion, with over 1,340 active impact investing organizations (GIIN). As a result, asset managers around the globe are looking to satisfy investor appetite for these types of investment strategies. However, before marketing themselves as “Impact Investors,” asset managers need to be aware of the many legal and compliance obligations and challenges that are attached to these strategies.

  • Greenwashing: Greenwashing – conveying investments and funds as overly environmentally responsible – has increased in recent years as more companies respond to public demand for responsible investing. This problem is worsened due to a lack of common vocabulary and regulatory guidance. Asset managers are often left to work out their own interpretations when determining what is considered a Responsible Investment, which may not be exactly in line with the standards that are being used by investors. This is why it is important for an asset manager to use appropriate terminology and agreed-upon classifications when marketing their strategies, to ensure faithful claims.

  • Conflicts of interest: Large asset managers tend to have multiple investment groups under the same roof that can be pursuing varying investment strategies at the same time. It is helpful to set clear internal processes to ensure that the various strategies are not in conflict with each other — or if they are, that a process has been established for dealing with conflicts. If reasons for investment differ, appropriate policies and procedures must be set up at the outset in order to deal with conflicts as they arise or prevent conflicts from arising entirely. For example, consider creating an investment committee that evaluates each investment holistically.

  • Reliance on Third-Party Service Providers: Due to the lack of a uniform terminology, asset managers typically rely on third parties to provide the classifications for compliance frameworks. However, third-party providers can make significant errors when aggregating data or setting up a custom index, which can lead to an investment that is inconsistent with a client’s initial mandate. Therefore, it is critical to conduct appropriate due diligence of third-party service providers on the front end in order to maintain a robust compliance framework throughout the lifecycle of the relationship with the provider.

  • Reporting: Currently, there are numerous approaches asset managers may look to when it comes to measuring Impact Investing because of the lack of uniform guidelines in the space. As a result, it is important to agree on a framework ahead of time in order to provide accurate and timely reporting for clients. If an investor wants reporting based upon a set of classifications that an asset manager is not familiar with, they must make sure beforehand that the underlying investment strategy can accommodate the classifications and is consistent with their own compliance framework. Asset managers should also consider any specific duties that arise from becoming a signatory to a particular initiative or investment mandate. For example, signatories to PRI commit to six overarching principles designed to show support for ESG factors and hold companies in which they invest responsible for ESG failures.

  • Responding to Investor Due Diligence Requests: During a due diligence process, investors will likely seek to determine an asset manager’s operational competence and the ability of the management team to follow through on the Impact Investing mandate. An asset manager should typically be ready to address the following:

  1. The investment process and its pursuit of Impact Investing goals;

  2. How the underlying investment process achieves the goal of Impact Investing;

  3. What criteria are used to measure attainment of Impact Investing;

  4. The experience and expertise of the investment team;

  5. Compliance, legal, and operational support allocated to the Impact Investing strategy.

As this asset class matures, asset managers must take the time to understand the legal and compliance challenges that are associated with managing this type of strategy. Those who fail to build out a robust compliance and legal framework at the outset, run the risk of reputational damage, regulatory penalties, or being unable to capitalize on the investor demand for Impact Investments.

For more on legal and compliance considerations for fund managers, download Vadim’s recent article in The Review of Securities & Commodities Regulation.

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