Introduction
How can the Cayman Islands support sustainable business practices and combat climate change?
ESG factors – risk and opportunity perspective
Disclosures on ESG integration
Ensuring investor protection


Introduction

When it comes to tackling global challenges, from climate change to population growth, it is not just activists, politicians and scientists who are seeking to bring about urgent action – the financial services industry also has an important role to play.

Using financial markets as a force for good was one of the themes discussed at Climate Week NYC 2022, where the opportunity was discussed for international finance centres like the Cayman Islands to make a genuine impact on how environment, social and governance (ESG) develops within the alternative investment industry.

However, in order for the financial services industry to better understand how it can affect transformational change, there needs to be a wider understanding and consistency around the use of the term "ESG".

The conversation around ESG is clearly much broader than just climate, but climate change has been identified as one of the greatest long term and global risks that humanity is facing, and so it would be unusual if a reference to ESG did not intend to take into account climate. The three aspects of ESG are highly connected and can be symbiotic in nature, together contributing to long-term sustainability. This is why they have been linked in this one term. However, the depth of attention on other aspects, including under the "social" or "governance" pillars of ESG, is not always apparent.

In fact, each of these components are in themselves important and complex topics that need to be considered on a standalone basis. It is important not to slip into using the term ESG when, for example, the focus is really only about the environmental aspects. This, of itself, can contribute to a form of greenwashing or confusion.

How can the Cayman Islands support sustainable business practices and combat climate change?

The Cayman Islands is an important international finance centre. It may be small in terms of its geographic size, but it is an important offshore centre with over 28,000 regulated funds. Any regulation within the Cayman Islands, including with respect to the funds industry, can therefore have more wide-reaching and global impacts. However, deciding the best way to go about regulation is not straightforward, especially as inconsistencies have emerged between other jurisdictions.

A focus for regulation in the investment funds industry in the Cayman Islands needs to include anti-greenwashing measures. Investor protection is at the heart of the Cayman Island Monetary Authority's (CIMA's) approach to regulation of the industry and so investor protection would likely be a key consideration for any new regulation in this area. Greenwashing encompasses a broad range of misrepresentations – for example, a fund manager misrepresenting their own sustainability-related practices ranging from the inappropriate use of specific sustainability-related terms, or, at the other end of the spectrum, deceptive marketing practices.

Unfortunately, descriptions of sustainability and ESG practices have been so generic that investors do not always know what they are getting. Often, they have to dig down to portfolio composition to understand more about what ESG really means to the fund or the manager. While institutional investors might be well placed to do that, many private investors (let alone retail investors) will not necessarily appreciate the distinctions between the different approaches to ESG and the term "ESG fund" on its own has no clear meaning. While it is true that greenwashing may be dealt with in claims of misrepresentation and misleading conduct, the aim of any such regulation is actually to provide guidance to prevent greenwashing arising in the first place. This is a much more efficient and less expensive way of policing greenwashing (ie, rather than relying on the court process).

ESG factors – risk and opportunity perspective

The three ESG factors can be looked at from both a risk and opportunity perspective. Risk assessment is already well understood to be a key component in investment decision-making. Historically, environmental and social factors were perhaps considered to be less widely relevant to investment decisions than they are today. The rise in awareness of issues surrounding climate change, as well as events such as the Me Too movement and Black Lives Matter, have brought environmental and social issues to the fore. They are now broadly considered relevant to a wide range of strategies, although how material they are to a strategy is another question.

It is the fact that ESG factors are considered to be so much more relevant to investing today that many argue that the term "ESG investing" will eventually become superfluous – namely, that the integration of ESG factors into the investment process, at least from a risk management perspective, will become part of the normal course of business. Indeed, many investment managers now commit to integrating ESG into their investment decision making and risk management processes. However, one of the greatest risks on the greenwashing front could potentially be in this category of "ESG integration".

Any new regulation should be mindful of the risks arising in this category and recognise the differences between funds which are looking at ESG from a risk or opportunity focus or both.

Disclosures on ESG integration

As investors might want to be able to distinguish between asset managers that are integrating ESG factors into investment processes and those that are not. Therefore, disclosures on ESG integration can be valid and may give comfort to investors.

However, investors should be clear that this does not of itself create an ESG investment and such funds should not be sold as ESG funds or the like. For example, ESG factors may be considered but ultimately determined not material and therefore have no real bearing on the investment decisions or strategy. This is very different from funds that incorporate the three factors, and/or sustainability considerations, into their strategy so that these factors play a significant role in the investment selection process.

The industry consultation and feedback that has been seen in response to new and proposed regulation in the European Union, United States, Hong Kong and elsewhere is useful to consider when constructing the form of rules in the Cayman Islands as these rules should be practical and impactful (ie, designed to achieve the objectives without putting undue burden on funds).

Ensuring investor protection

ESG has been exploited by those looking to take advantage of consumers' interests in green and sustainable products. Anti-greenwashing measures should ensure a level of investor protection against this, ensuring that funds marketed as ESG-focused funds are making meaningful changes to their investment strategy, that they properly disclose and are transparent about ESG-related risks and that they are held accountable through reporting.

The regulator in the Cayman Islands has ESG regulation as a top agenda item, and it has already put out some advisories stressing its role in investor protection and the importance of fund operators identifying, measuring, monitoring and managing material ESG-related risks.

A desire for the Cayman regulator to start to direct what a fund can invest in or its investment strategy is not expected. It is more likely that CIMA will focus on investor protection, which is where anti greenwashing measures come in, but it must now be seen what emerges from the consultation.

Questions still remain – for example:

  • How broad will the regulation be?
  • Will it capture all funds or just those holding themselves out as ESG related or focused funds?
  • Will it be in the form of a prescriptive code or rather in the form of guidance?

For further information on this topic please contact Kate Hodson or Joanne Huckle at Ogier by telephone (+852 3656 6000 or +1 345 949 9876) or email ([email protected] or [email protected]). The Ogier website can be accessed at www.ogier.com.