Risk management

Gianluca Frena: “Sustainability risk and ESG are not the same”

Gianluca Frena is a senior manager at Deloitte. Photo: Romain Gamba/Maison Moderne

Gianluca Frena is a senior manager at Deloitte. Photo: Romain Gamba/Maison Moderne

Investors sometimes misunderstand the meaning of ‘sustainability risk’, says Gianluca Frena, member of the Association of the Luxembourg Fund Industry’s sustainability risk management committee.

Frena, a senior manager at Deloitte, spoke with Delano ahead of the European Risk Management Conference, organised by Alfi and the Luxembourg Association for Risk Management (Alrim) on 16 June 2022.

Aaron Grunwald: There’s a lot more money flowing into private market funds. From a risk management perspective, is that raising alarm bells?

Gianluca Frena: The fact that we have more money coming into the sector will not necessarily drive additional risk. Although we see, from the regulatory perspective, that some pockets of risk have been identified, for example, liquidity mismatch in specific asset classes, there is not always the right understanding that the profile of liquidity that is apparent to the investor is the same one ofthe assets that the fund is being invested into.

What’s behind the misperception?

The thing is, we do consider that we can buy into a fund and it’s essentially like putting money in the bank. There is a need for people to understand that, in fact, this money has been invested, and there can be different risk profiles and different characteristics which are being invested into. Clearly a real estate fund, even if it’s open-ended, will not be like giving money to the bank. We have other cases, maybe investing in specific assets like high yield, which are typically almost very liquid. But in certain situations, the tap can dry out. And we don’t consider that when we perform our investment.

How does the approach vary for risk managers at illiquid funds? 

They work with different assumptions than the liquid world. [For liquid investments] you assume that prices that you see for the securities are fair, they have been traded by thousands of people around the world.

On the other hand, in the alternative world, as you don’t have the data, you cannot rely on the price. You have a price, but you know that potential factors are going to drive this price in the future. It will be up to you to think about them and to try to model them.

Is there anything about sustainability risk that you’d like to clear up?

The importance of making a clear differentiation between what is ESG investing, how I select my investment in a way that the company I’m investing into will [or will not] potentially cause harm to the environment, or has solid social and governance practices, and so forth. And then there is the element of sustainability risk. That is, how my assets are going to be impacted by things like climate change, by things like increased emission costs, like increasing magnitude and frequency of meteorological events. Sometimes when I hear people talking about ESG, they seem to mix these two topics that, if you look at them from the right perspective, are not the same, they’re very different.

Sustainability risk doesn’t exist only if you care about ESG. You have sustainability risks that are there regardless, which is important that we start understanding because we might have real risks that will come up, not in the next year, but potentially the next five, 10, 30 years, as we see the development of emission levels and consequent regulation that is coming to try to fight it.

So sustainability risk could mean, if we’re talking about a real estate fund, that climate change could damage the property?

It’s not just about the physical hazard, it can also be the cost of consumption, it can also be how much fuel they use to heat or whether they have some photovoltaic panels in order not to be so [energy] dependent. So, you see, it’s not an easy topic. There are always multiple ways of looking at the same things and to get different understandings of what are the risks, what are the opportunities and how to define how to handle that.

Originally published in Delano’s June 2022 print edition.