By Hamlin Lovell, NordicInvestor

This interview is part of our upcoming report on ESG in the Nordics

NordicInvestor interviewed Annika Esono Manninen, Head of ESG at OP Asset Management, part of the OP Financial Group the biggest bancassurer in Finland with AUM of over 100bn euros. OP Asset Management manages 31.4 billion in OP’s own mutual funds as of Q3 2021; mandates of private, wealth and institutional clients, and the life and non-life assets for OP Life and Pohjola, excluding unit linked

ESG coverage: application varies by strategy and for external managers

At a high level, ESG is integrated into all asset classes, but applied differently, and the level of integration is deeper in some than others. For instance, different methods apply for external managers and direct private equity. “External managers do not always follow exactly the same approach and hedge funds can apply ESG very differently from traditional fundamental equity managers. Some minimum requirements are set for external managers: they must have an ESG policy, should integrate ESG and should pursue active ownership for equities, but they do not always apply ESG in exactly the same way. We also engage with external managers to try and improve their ESG policies,” says Manninen.

Public and private companies require different methods. “For listed equities we can take a more quantitative approach, but data is not always available for private companies so we need to dig deeper into each one. There is no standardised method and the approach is also constantly evolving,” she explains.

Exclusions, benchmarks, best in class, and transition: some funds use ESG benchmarks

OP runs funds, and most of them carry out one or more of five approaches: exclusionary screening; monitoring of international norms; ESG integration; voting at general meetings; shareholder engagement. For instance, some equity funds do all five, and some corporate bonds do four of the five but cannot vote at general meetings.

Exclusions cover companies breaching international norms, controversial weapons, and for coal the threshold will be reduced from 25% to 20% from January 2022. Some asset managers in Finland do not publish exclusion lists, but OP does so on its website. The October 2021 exclusion list contains companies involved with coal, inhumane weapons, and breaches of international norms. The exclusions apply to active equity and fixed income investments, as well as single company derivative but not to index derivatives.

The minimum exclusion list is between 100 and 200 companies but it varies by product range with some responsible products having a wider range of exclusions. For instance, OP Sustainable World also excludes alcohol, tobacco, gambling, weapons, adult entertainment and nuclear energy and avoids businesses involved with child labour or corruption. thematic ESG funds, such as OP-Clean Water, have stricter fossil fuel related exclusion policies than other funds. Additional exclusions for these funds include for example unconventional oil and gas, and all fossil fuel business with a 50% revenue threshold,” says Manninen.

Whereas some asset managers in Finland currently use only traditional benchmarks, OP is using ESG benchmarks for many products. OP’s own index funds mainly use a range of ESG benchmarks with their own exclusions: MSCI ESG Universal Index Family. These include MSCI Pacific Universal ESG; MSCI North America ESG; MSCI Europe ESG; MSCI World ESG; and MSCI Nordic Countries ESG.

Beyond ESG benchmarks there are other specialist benchmarks focused on climate, carbon or particular sectors. For instance, the OP Climate fund uses the MSCI World Climate Paris-Aligned benchmark while OP Low Carbon uses MSCI ACWI Low Carbon Leaders index. Some products use a sector benchmark that is not an ESG index per se but rather a sector index: OP Clean Water uses S&P Global Water.

The firm is also researching various climate benchmarks.

One passive fund in the range does not have an ESG index, the OP-Finland Index fund, uses a conventional benchmark – Nasdaq OMX Helsinki Benchmark, for two reasons. “From an ESG perspective, the Finnish market already has such high ESG scores and it is a small market, so an ESG benchmark doesn’t really provide added value from a sustainability perspective. Also, within the Finnish market we have more direct access to engage directly with the companies,” says Manninen.

Some of the thematic products apply absolute ESG minimums and also use best in class peer group analysis.

Data and analytics: in house and qualitative analysis essential to gauge transition

OP has built its own ESG tool for understanding the future trend and momentum in companies’ ESG performance, which is more important than their current performance.

Internal analysis is also needed to plug gaps in coverage. “The larger global data providers – such as MSCI, Sustainalytics and ISS – do not always cover smaller companies, especially Finnish ones,” says Manninen.

Even where some quantitative data exists, OP feels the need to complement this with more qualitative analysis, which by its nature cannot be aggregated. “We have built our own ESG tools to pull off Bloomberg data and SASB modelling,” says Manninen.

OP expects to see both consolidation and start-ups in data provision. “There is plenty of space for new ways of doing things,” says Manninen. “This is not just about more start-ups providing data and new way of collecting company level data, but also looking at it from an investor’s perspective.  Data needs to be adapted to consider different asset classes, enhance the investor’s ESG processes and understand what is truly material from a risk-return perspective. We also want to measure direct and indirect real world outcomes from investment decisions,” says Manninen.

Going forward, new accounting standards could be helpful. For instance, “IFRS standardised sustainability data might make it easier to compare companies,” says Manninen.

Thematic products include carbon, climate and water; impact products invest in private companies

Thematic products include the internally managed OP-Sustainable World; OP Clean Water; OP Low Carbon World and OP Climate, which invest in public companies that are building solutions in terms of climate change adaptation and mitigation, and also clean water fund solutions.

In addition, OP has an impact fund for professional investors, OP Finnfund Global Impact fund, which seeks for measurable positive impact by investing in private equity and debt within emerging markets targeting SDGs. “Investing in private companies can give us more direct real world impact,” says Manninen.

Thematic strategies naturally lean towards some of the SDGs, but do not exactly map onto them. The Impact fund product is more naturally tilted to certain SDGs.

Active ownership: voting globally and engagement  mixes direct and collaborative approaches

Engagement and proxy voting are more manual in Finland while service providers assist with the process globally. OP votes in up to a thousand AGMs both in Finland and globally, with a sustainability approach.

In addition to voting, OP carries out direct engagement based on screening for violations of global norms and starting a dialogue in cases of violations.

Collaborative engagement, eg through Climate Action 100 Plus and Sustainalytics, has covered issues including the circular economy and plastics.

“We probably have most impact in Finland, where we engage directly, but it is harder to measure our impact when we are part of a larger group of investors engaging or voting on certain topics,” says Manninen.

Climate targets and reporting: carbon neutrality by 2050 for investments but 2025 for the firm

OP targets net zero by 2050, and a 50% reduction by 2030 compared with a 2019 baseline. Other interim targets are in progress. Though Finland has a national target of 2035, which does filter through to Finnish companies that OP invests in, OP invests globally so cannot expect to align with the 2035 target everywhere.

Carbon and green reporting is expanding: ”we have been reporting carbon footprints for over 5 years. We also report funds’ ESG scores and levels of green revenues as part of the monthly ESG reports. In addition we analyse fossil fuel exposures for institutional clients. This is being expanded, with more detailed reporting expected in future, but additional metrics have not yet been finalised,” says Manninen .

Scope 3 carbon data often needs to be estimated with the help of third party providers, to produce comparable data that covers enough companies. ”We need to get comfortable with data providers’ methodologies to be sure that they are aligned with how we see things,” points out Manninen.

At the corporate OP level, there is a different head of ESG, and also different climate targets: carbon neutrality in terms of scope 1 and scope 2 emissions by 2025.

EU Sustainable Finance framework: early stage and subjective, awaiting a broader environmental taxonomy and the social taxonomy

Manninen is cautiously optimistic about the EU rules but they are not final and the timing is uncertain: “The framework will eventually improve company reporting, but it will take time and many companies are not yet reporting the required data. The taxonomy will provide one framework for understanding what is green, but it is not the only one. The rules are not final yet. We need to figure out which companies will transition their business models to see increased taxonomy alignment in future. The SFDR provides a framework of what to research and where but asset managers have too much freedom to determine if a product is article 8 or 9, and the rules are not final yet. The second level disclosures are not yet in place. Therefore, the SFDR classifications are not really very helpful for manager or fund selection at the moment. It is also important to remember that SFDR is about transparency and disclosure, rather than a labelling exercise. We expect to increase SFDR 8 funds but will also be allocating to 6 and 9”.

Regarding fund selection, the EU sustainable rules also need to be seen in the context of other EU regulations that they interact with. “The MiFID II amendments will let clients specify their sustainability preferences,” says Manninen. The rules on integrating sustainability factors, risks and preferences are expected to come into force in August 2022. It could take time – and possibly some trial and error – to see how this process works.

Whether the EU rules eventually move impact investing into the mainstream really depends on how impact investing is defined. “The terms can be ambiguous and are often confused. ESG and Impact are two very different things, which can be defined differently by different investors,points out Manninen.

It is too early to view the taxonomy as a way to measure impact investing. The environmental taxonomy is being expanded: the climate change adaptation and mitigation parts start in January 2022, while the other environmental objectives around water, marine resources, the circular economy, pollution, and biodiversity, are expected to start in 2023. “We are also awaiting the social taxonomy,” says Manninen. A draft report on this has been published in July 2021.

“The main goal for any investor is to enhance returns and consider ESG risks using their own analysis and work. It will take time to see how the EU framework evolves and how it is used,” she concludes.