Climate change is the most important environmental, social, and governance (ESG) topic in Europe, according to a new report. Nearly 77% of insurance companies address climate change explicitly in their responsible investment policies, as do 53% of the pension funds.

French, Dutch, and UK asset owners are more likely to address climate change explicitly in their responsible investment policies than their counterparts in Italy or Switzerland, research and consulting firm Cerulli Associates says in its latest report.

“Although climate change is the key topic addressed in many European asset owners’ responsible investment policies, not many set targets to reduce climate-related risks or report their performance against these targets,” says Justina Deveikyte, associate director in Cerulli’s European institutional research team and lead author of the report.

Cerulli’s survey finds that on average, nearly 70% of European asset owner respondents do not set carbon-footprint reduction targets for externally managed portfolios. This percentage is lower in the Nordics, where around half of the asset owners surveyed do not set such targets.

ESG capabilities are now integral to European asset owners’ manager selection. “The most important factor asset owners assess during their selection process is the level of integration of ESG personnel, because the effectiveness of ESG frameworks depends on it,” says Connor Bigland, an analyst in the European institutional research team and co-author of the report.

“This factor reflects how well a manager has embedded ESG into their firm culture, which is of growing importance to European asset owners.”

ESG integration

The starkest difference between European insurers and pension funds when it comes to selecting an asset manager is in their views on integrating ESG performance into manager remuneration. For the pension funds Cerulli surveyed, it is the least important factor, but insurers place it sixth of 11 factors.

More than 45% of insurer respondents say linking managers’ compensation to ESG performance is very important, compared to just 30% of pension fund respondents. None of the asset managers that took part in Cerulli’s research have developed a fee structure that allows them to link compensation to ESG performance.

The survey also finds that 68% of insurers and 63% of pension funds among the respondents plan to switch from passive to more active investment approaches to improve ESG integration over the next three to five years.

Cerulli expects more demand for enhanced index approaches, which add layers of ESG capabilities to a traditional index tracker fund. These funds sit somewhere between traditional passive and traditional active strategies and any new entrants to the European passive market must offer customizable ESG indices if they are to be competitive, the report says.