In this episode of the Sustainable Finance Guernsey channel, our host, Brandon Ashplant, speaks to James Hay, Principal Climate and Sustainability Advisor of Pinsent Masons.
The conversation explores the complexities of transition planning and transition finance in asset management. He discussed the focus on financed emissions and the challenges asset managers face in developing effective decarbonisation plans. James highlights the distinction between operational emissions and financed emissions, and discusses the practice of 'paper decarbonisation' where asset managers shift investments without impacting real-world emissions.
Transcript below:
Brandon (00:00)
Hello and welcome to the latest episode of the Sustainable Finance Guernsey podcast, rated one of the top 10 most useful sustainable finance podcasts by Green Finance Guide. Guernsey is one of the jurisdictions leading the way in green and sustainable finance. And as part of this podcast series, we will be speaking to and learning from some of the leading global figures in the field.
My name is Brandon Ashplant, and I'm Technical Manager of funds and private wealth here at Guernsey Finance, the island's promotional agency for the financial services sector. Today I'm talking to James Hay of Pinsent Masons. James advises financial services firms and corporates on a broad range of sustainability matters with a focus on complex ESG regulatory change, including sustainable finance disclosures, corporate sustainability reporting and net zero transition planning. At Pinsent Masons, a multinational law firm with a reputation for delivering high-quality legal advice rooted in its deep understanding of the sectors and geographies in which their clients operate. So without further ado, welcome, James. It's great to have you on the show.
James Hay (Pinsent Masons) (01:16)
It's a pleasure to be Thank you.
Brandon (01:18)
Can we begin with you telling me a bit about yourself, how you came to work for Pinsent and Masons and in the sort of climate and sustainability team in particular?
James Hay (Pinsent Masons) (01:30)
Certainly. So I had an interesting career journey up to this point, maybe as a typical millennial. I actually began my career as a corporate lawyer in Hong Kong. But I became interested in sustainable finance and investments quite early on to my career and actually was undertaking the CFA program at the same time as being a legal trainee, which was quite a challenge.
So after qualifying as a corporate lawyer in Hong Kong, I did my MBA at INSEAD, and then I joined a sustainable investment firm called Main Street Partners in London. That's really where I got the bulk of my experience in this field. And then, after about five years or so, Main Street was acquired by a company called All Funds. And at that point, I decided to move over to the consulting side of things where I joined the new financial services ESG consulting team at KPMG. Two years later, I decided to join Pinsent Masons and really the decision was to combine the legal expertise that Pinsent Masons has with the consulting expertise that I was gaining at KPMG to bring it together into really a combined offering. And that's been, I suppose, quite a powerful offering and really distinguished in the market because often those two things don't go together. And so it's great to provide our clients with that holistic advice.
So that's been quite a compelling proposition for our clients over the last two years.
Brandon (02:53)
So, as an advisor on climate and sustainability, how has the landscape of projects and advice you have been working with clients changed over the last five years or so?
James Hay (Pinsent Masons) (03:07)
That's right. So this field is changing so often. In fact, I feel like it changes every 12 months or so. And this is really as we process new regulations that have been coming in and also understanding the changing business environment as a result of political change or as a result of new risks emerging. Now, for the past five years or so, the majority of our work has been regulatory driven. And that's really because governments implemented a constant pipeline of new regulations.
I suppose that's really what's been responsible for all the acronyms in ESG, because it just had so many regulations to handle. However, there's definitely been a bit of a change recently. That was predominantly driven by the EU slamming the brakes on some new sustainability regulations following the European parliamentary elections in 2024, when the centre-right coalition gained a majority. They favoured policies promoting international competitiveness over sustainability.
Also, of course, we've had political developments in the US as well. And even in the UK, we've seen governments changing and also potentially backpedalling on some sustainability ambitions while continuing to drive forward some others. So in the EU, where I suppose the majority of these regulations were coming out from, this triggered the omnibus simplification process. And this is still ongoing. So there's a lot of change at present as well.
And essentially this omnibus is a negotiation between the European Commission, the European Council and European Parliament over how much to scale back sustainability regulations and promote international competitiveness. Now these tripartite negotiations, as you can imagine, are very complicated. And this is why there's been so much policy change over the year. And that's caused a lot of apprehension among business because what they really like is, of course, so, you know, with this potential pause in the regulatory pipeline, companies are now really looking beyond mere regulatory compliance, and they're now thinking more about sustainability risks, not just in their operations themselves, but also in their supply chains. You know, as I say, things change every 12 months or so, and I think this year a lot of companies have been focusing much more on the risks in their supply chains.
Brandon (05:24)
It would be great to talk about the transition planning and transition finance a little bit more. Could you start by just explaining what transition finance means in practice and how it differs from traditional routes of green finance?
James Hay (Pinsent Masons) (05:46)
Certainly. So look, people in sustainability may disagree over definition of transition finance, but I'll try and provide a broad view so you can drill down a bit. So essentially, transition finance is about providing capital to activities which support that transition to a low-carbon economy. And so we can also use the term transition investments to mean something similar in the context of investing. However, the point of using this term transition finance rather than say, green finance or maybe sustainable finance is really to distinguish activities which achieve that transition aim, which are not typically considered green. So sometimes people might refer to green finance as brown to green and transition finance maybe is brown to lighter brown. But there's really a broad spectrum there, which is why you can get those disagreements.
Brandon (06:41)
And it's great to understand the difference between transition finance and green finance. What about transition planning? Where does that fit in?
James Hay (Pinsent Masons) (06:52)
Certainly. So when we think about transition planning, this is going beyond thinking about pure activities, such as renewable energy, thinking more about how entire companies are transitioning. So thinking more on the of the narrow side of things. For example, the financing of renewable energy could be considered green, whereas the financing of natural gas, a fire power plant would not be green, but could be transitioned, where actually it would be potentially constructed to replace a coal fire power plant. And then that would potentially meet that definition of transition finance, depending on how strict your parameters are. But now if we expand that concept, we can think about the financing or the investment into companies whose core business is not necessarily green but they are seeking to decarbonize and make themselves more sustainable. And that's really where that broader idea of transition planning comes into effect.
Brandon (07:51)
Are there emerging principles or standards that asset managers should be more aware of?
James Hay (Pinsent Masons) (08:00)
Yeah, so there are a lot of standards when it comes to transition planning. A lot of guidance documents have been published over the recent years. So I think probably one of the most important at the moment actually has been the Transition Finance Market Review in the UK. And they published a long report in October 2024. And that really set out the current market practice and also general understanding of transition finance.
However, there have been a number of other publications from international coalitions like GFANS, like the ISSB, etc. So there's quite a lot out there. But for anyone who's really interested in digging into all these different guidance documents, the Transition Finance Market Review paper actually contains a lot of those. And so it's a really good resource, to conduct further research.
Brandon (08:54)
What are some of the factors that are leading to firms you're working with in taking transition planning a bit more seriously?
James Hay (Pinsent Masons) (09:03)
Yeah, so there are several drivers for this. So the first is that many companies, both financial services firms, as well as corporates, have previously announced net zero targets. So transition planning essentially is the process of figuring out how they're going to achieve those targets. The second driver really is stakeholder pressure, such as investors wanting listed companies to publish transition plan or government procurement policies requiring suppliers to have such plans.
And this can also include banks or investors wanting to see a transition plan before they lend to or invest in the company. So we're at quite an early stage when it comes to that stakeholder pressure. Certainly, the banks I've spoken to, they're interested in learning how they can engage their borrowers on their transition plans, but they're not quite at that stage of remaking it a requirement of their lending. And then the third driver is regulatory compliance. So both the EU and the UK, are currently introducing regulations which may require large companies to publish transition plans, albeit the caveat there of course is these current negotiations that are ongoing. And there was a consultation earlier this year published in the UK about really how ambitious the UK should be when it comes to mandating transition plans. So this was one of the key challenges for companies, particularly those that have set net zero targets, is understanding actually how difficult it can be to achieve those net zero targets and what that really means in practice. And this is why I think, you know, governments regulators are really having a deeper think about what should be mandatory under regulation, whether a 1.5 degrees target is mandatory, whether it's mandatory for companies actually to publish and implement these plans or merely to set their ambition and describe how they're going to achieve it.
So for me as a consultant, that's really the core of my advice is actually the practicality of achieving those targets and what that will mean for business strategy.
Brandon (11:04)
And how can the asset management industry, more specifically, look at transition planning and finance?
James Hay (Pinsent Masons) (11:14)
So when asset managers think about transition planning, they need to think about their own business activities, but they also need to be thinking about the transition plans of the companies in which they invest. And in reality, those two aspects are linked. So the carbon emissions associated with an asset manager's operations, such as its office facilities or business travel, are really a fraction. I mean, less than 1% of their overall emissions. 99% of an asset managers' emissions come from their finance activities, the investments they are making. So this means when an asset manager is setting a net zero target, yes, they should have an ambition to reduce their own operational emissions, but really they're thinking about how to reduce those financed emissions. But therein lies the challenge, of course, because asset managers, particularly in listed markets, they don't have control over their investments, so they can't force management to set decarbonisation plans. What typically happens instead is that asset managers may sell some of their more carbon-intensive investments and reinvest in less carbon-intensive investments. This will reduce their financed emissions, but really that won't change any emissions in the real economy. And as a result, this practice has been known or referred to as paper decarbonisation, where they reduce their emissions that they report in their periodic disclosures.
You know, when we think about this, if an asset manager is really committed to net zero, they need to come up with a transition strategy. And I focus on four key strategic pillars for this. The first essentially is what funds they are launching or mandates they are managing. And I refer to that as their product strategy. Secondly, how are they thinking about climate risks? How do they integrate climate considerations into the investment process? And so I refer to that as their investment strategy.
Thirdly, how do they engage with their investing companies and vote their shares? So I refer to that as their stewardship strategy. And then fourthly, how they seek to mitigate their own operational emissions, albeit a small fraction of their overall emissions. So I refer to that as their operational strategy. And so by breaking it down in this way, rather than focusing on purely that decarbonisation number, I think asset managers can understand how their business strategy informs and influences their transition strategy because the mistake I think that some asset managers make is they're looking to achieve a certain decarbonisation objective without understanding actually how they are dependent on their business strategy. Are they an active management house? Are they a passive management house? Are they managing mandates? Are they distributing funds to the market? So there are many different kinds of business strategies that asset managers can lead and that will really dictate what they can achieve in their transition strategy.
Brandon (14:09)
Looking at the asset management industry then, what is the current status of sort of mandatory climate reporting and how do you see this sort of simplification versus deregulation narrative around climate reporting impacting firms?
James Hay (Pinsent Masons) (14:27)
So right now, and I'll focus on the UK just because it's going to change significantly by jurisdiction, but in the UK at least, we have climate risk reporting. So some people might know this as TCFD reporting, and that stands for the Task Force for Climate Related Financial Disclosures, where the UK regulator said, we would like asset managers basically to disclose climate risk and how it's integrated into their investment strategy in accordance with the TCFD recommendations.
However, we're now thinking about your mandatory transition plans and there's both constellations that I mentioned earlier that was led by the government about how large companies in general should disclose transition plans. But the FCA in due course will also consult on mandatory transition plans for the financial services sector, including asset managers as well. So these transition plans for asset management firms are not yet mandatory, although they're to a certain extent, some of the TCFT recommendations do suggest disclosing how you are thinking about climate risk in your business strategy, and that might then lead on to transition planning-related disclosures. But it's not quite the same as complying, for example, with UK Transition Plan Task Force disclosure framework, which really go much further beyond the TCFT recommendations.
Brandon (15:46)
How do you see the now increasingly sort of mandatory reporting driving or drive towards that, know, changing behaviour for firms? You know, is that happening yet?
James Hay (Pinsent Masons) (15:58)
Yeah, so I think having mandatory reporting has created more consistent practice across the industry. Beforehand, a number of firms were producing disclosures, particularly in their marketing material to investors, while some other firms were silent on climate risk and their metrics. So it certainly established a minimum level of disclosure, which is helpful. However, I think even some of the regulatory disclosures go beyond perhaps what retail investors or consumers might really be able to understand. So a lot of disclosures, I think, are potentially more useful for institutional investors, but they might also typically have their own RFP questions or their own due diligence requirements that go above and beyond the regulatory disclosures as well. So it certainly has been useful, I think, to create more standard disclosure practice across the industry versus just really the wide range that we saw beforehand.
Brandon (16:55)
And if not reporting, what is driving, you know, behaviour change?
James Hay (Pinsent Masons) (17:01)
So I think political developments around the world are also driving change among asset managers. Certainly in the US, there has been a market change in practice where ESG disclosures really are having to be stripped out of marketing materials. So you almost have US-facing disclosures and European-facing disclosures, which can be really quite a challenge for asset managers. I think we're also seeing firms thinking about their products, whether they are actually sustainable investment products or if they're more traditional funds. And whereas I think we had seen a number of firms really disclose sustainability-related information across all of their funds. What I'm starting to see, this is still quite early days, is that they're focusing on the disclosures for their sustainable funds now and for their traditional funds. Maybe they are stripping some of that back to comply with regulatory requirements because those investors are focusing more on the financial risk and return characteristics of the fund rather than all the sustainability disclosures. Not to mention of course that producing these disclosures can be expensive. It does require a lot of time and resources at firms.
Brandon (18:13)
And to what extent is managing risks and opportunities around climate and sustainability understood to be as a core part of firms fiduciary duties across the different types of institutional investors, such as pension trustees.
James Hay (Pinsent Masons) (18:32)
So we can think about fiduciary duties when it comes to climate change and sustainability, I suppose, at each layer of the investment chain. So let's start at the bottom. Let's think about your corporates, your companies that are being invested in. So whether company directors have a fiduciary duty to consider sustainability obviously will depend on local law. But in the UK, at least, directors are required to consider it. But it's debatable whether it's really a positive duty to integrate sustainability into business strategy. In essence, that's because UK courts are very reluctant to second-guess how directors run companies. Nonetheless, of course, you may have particularly ambitious individuals as directors, and so they are driving the integration of sustainability into business strategy. Or you may have company management who really believe, of course, that integrating sustainability is good business. And that certainly has been a key message for many years now. Now, moving up the investment chain, asset managers have a fiduciary duty to act in the best interest of their investors. And of course, this will also include taking into account financial material risks, which can include sustainability risks. But what this would not include, for example, would be a positive duty to target certain sustainability outcomes unless this is expressly set out in the investment mandate.
And you might commonly see that in sustainable or impact investment funds where they really aiming to achieve certain impact outcomes. Now, I think where this discussion gets really interesting is when we think about asset owners and more specifically, pension funds at the top of that investment chain. Yes, the question is, do pension funds have a duty to invest sustainably? Now, this has become an increasingly important topic recently because pension funds are debating whether to divest from fossil fuel companies, whether to increase investment now in defence, which previously was seen as something that's not particularly sustainable. And also something that can be a bit of a political hot potato, like excluding companies associated with the ongoing events in Gaza. Now, in the UK, the law does permit pension trustees to take sustainability considerations into account. I think that word permit is quite useful because there are limitations here, and it's not, again, a positive duty to take such considerations into account. So if you think about the purpose of pension fund, its primary purpose is to provide their beneficiaries with retirement benefits. So essentially, where the law permits trustees to take sustainability into account is where adopting a sustainable investment approach would not negatively conflict with that purpose. So, for example, where it might improve the risk-return profile of their investments, but at the very minimum, not be to its financial detriment. So there are really two potential avenues for that financial detriment test. And the first is whether adopting a sustainable investment approach would result in worse risk-adjusted returns. For example, if sustainable investments were expected to underperform. The second avenue is thinking about diversification benefits. If you overly exclude certain sectors because you think they are not sustainable, then that might reduce those diversification benefits. And suppose actually a third avenue, which maybe is less related to the investments themselves, but it's more of an operational issue. What is the operational cost of adopting a sustainable investment approach? For example, it may require pension funds to invest in higher-cost products. Some of these ESG funds do come with higher management fees.
Additionally, if you are currently invested in a pooled vehicle that does not take a sustainable investment approach, you might have to segregate your assets out from that pooled vehicle. And again, that will actually incur additional costs. So these are much more practical costs, but they really do need to be considered by trustees because at the end of the day, even if the risk profile of the investments is not impacted, unless you can really point to some positive return, it'll be hard to justify those higher operational costs right now at Pinsent Masons, we are advising pension trustees on these issues and helping them to comply with fiduciary duties, thinking about these, some these quite tricky questions.
Brandon (23:04)
Is divestment part of the process?
James Hay (Pinsent Masons) (23:06)
Yes, so some pension funds in the UK have decided to divest from certain companies. An easy example might be fossil fuel companies, specifically coal mining as well. And this is because they think that such companies essentially have a limited life, right? That they might be stranded assets and not viable in the future. So they're looking to sell them now to avoid taking a write-down in the future.
However, there are some pension funds which have also taken some divestment decisions, where maybe it's not driven so much by the financial risk-return profile, but maybe more by political considerations. For example, defence companies, companies involved in the events in Gaza, et cetera. So it's a bit more of a challenging decision to reach because again, you've got to justify why taking those decisions does not result in financial detriment to the fund. But where you're excluding a small number of companies, then the loss and the diversification benefits will not be significant.
Brandon (24:11)
And how much is climate litigation considered a risk for directors?
James Hay (Pinsent Masons) (24:19)
So again, we can think about those three different layers of the investment chain. So I think climate litigation is quite important for corporates, potentially particularly for corporates which have high emissions profiles. We have seen new cases making their way through the courts trying to impose a liability on companies for their historic emissions. So, for example, fossil fuel companies because they have a large emissions profile. They are a potential target for such litigation. There could also be litigation brought against asset managers for not adequately considering sustainability risks that are financial material in their investment activities. And again, really the same pension trustees, while there's no positive obligation to consider sustainability in the investment approach, there is a requirement to think about financial material risks.
Pension trustees are not properly thinking about this, or they just outright refuse to consider sustainability; then yes, there might be grounds for potential legal action. So, climate litigation is becoming more of a risk because we're really seeing novel lawsuits being brought that are really testing the boundaries of law. And climate litigants have seen some successes. They've seen some setbacks as well. So, because this is an evolving space, think it is something that directors really should be thinking about more carefully.
Brandon (25:46)
And just finally, we have seen growing interest and political commitments to invest more in defence, particularly across Europe in the last few years. How is this impacting investment in sustainability and how is this being viewed, I guess, through a sustainability lens?
James Hay (Pinsent Masons) (26:08)
Yeah, so the complete 180 on defence investments over the past couple of years has been really interesting to see. You know, look, I think it's fair to be a little bit cynical about it, because as soon as defence became a political priority, the sustainability justifications for defence were published swiftly thereafter. So, look, the sustainability case for defence investments is the social benefit through the support of international peace.
Importantly, this is also linked to the United Nations Sustainable Development Goal number 16, which calls for peace and justice. Now, divestment campaigns in relation to companies involved in defence activities have been around for many years, and particularly more recently as well. Now, I think this has caused pension funds to be stuck in a bit of a difficult situation as they seek to benefit from the tailwind behind defence investments, while also being petitioned by some very loud and activist campaign groups, calling for them to divest from such companies for political or other reasons. And again, think given this difficult situation for pension funds and their fiduciary duty free duties, this really does underline the importance of getting proper advice as you seek to navigate between very loud interest groups and also their legal duties on the other hand as well.
Brandon (27:37)
Well, I'm afraid that's all we have time for today, but thank you very much, James, for joining us on the podcast today.
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