(Bloomberg) -- An ESG strategy that’s too controversial for US regulators and some major ratings companies has been embraced by Fidelity International and other European financial firms as a way to safeguard long-term returns.

Double materiality, whereby an investor doesn’t just screen for the environmental, social or governance risks facing their portfolio, but also measures its ESG impact on the world, isn’t incorporated in Securities and Exchange Commission rules or proposals. Nor does it shape the bulk of  ESG ratings provided by firms such as MSCI Inc. But in Europe, the idea is gaining serious traction in the market and among regulators.

Fidelity, one of the UK’s biggest money managers with more than $665 billion in assets as of June 30, now applies double materiality across all managed assets after incorporating the strategy earlier this year. In so doing, Fidelity hopes to capture financial risks that more traditional analysis might miss.

“The range of non-financial factors that influence financial value has increased and will continue to increase,” said Jenn-Hui Tan, Fidelity International’s global head of stewardship and sustainable investing, in an interview. “And that’s why we have that prominence of ESG factors in that process.”

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It’s the latest sign that the giants of finance are building one of the most far-reaching ESG tools into their financial management. JPMorgan Chase & Co. introduced a product last month that gives clients access to double-materiality analysis as a way to manage their financial risks. Robeco uses double materiality to manage about a fifth of its €178 billion in assets. And Germany’s DWS Group says it uses the method to drive investment decisions for equity, fixed income and multi-asset funds.

DWS is asking analysts and portfolio managers “to look inside-out, not just outside-in,” said Susana Penarrubia, head of ESG integration at the Deutsche Bank AG investment arm.

Fidelity uses 127 “materiality maps” to score companies from zero to three. A score of three indicates that a company is managing impacts with a likely “long-term benefit” to its value. Over a 10-year horizon, that line of thinking has the potential to increase the market value of Fidelity’s investment portfolios, according to Tan.

“Essentially, what our ratings do is they enable us to look at the risks of a business over a longer-term horizon than you would do by only looking at it through the financial materiality lens,” said Tan. “That’s where we see the value of this double-material concept and that’s why we think it helps us to become better investors.”

Read more: The ESG Mirage

The European Union, which is ahead of other jurisdictions in building a rulebook for ESG investing, has embedded double materiality into its framework. And in early 2023, the International Sustainability Standards Board (ISSB) will publish a global rulebook on sustainability and climate disclosure, with guidelines that may acknowledge the importance of double materiality over time.

Emmanuel Faber, chair of the ISSB, has said it’s his “mission” to ensure that companies produce “carbon warnings” a few years from now, just as they publish profit warnings today.

But such goals look set to meet resistance in the US. “The SEC will find it difficult to back an investing concept whose short-term fiduciary value can be difficult to prove,” said Rob Du Boff, senior ESG analyst at Bloomberg Intelligence. 

Read More:  BNP, Nonprofits Seek Wider Disclosure of Nature-Related Impact

Fiduciaries must account for ESG issues because it’s necessary for managing portfolio risks, “not because it’s the right thing to do and I don’t see that priority shifting anytime soon,” he said.

The SEC is already trying to assure markets that its efforts to police ESG labels on some investment funds don't constitute agency overreach. It's faced criticism from the fund industry, which supports updating name rules but objects to the SEC stressing labels’ importance compared to other disclosures, Bloomberg Law wrote this month.

MSCI, among the world’s most-used providers of corporate ESG ratings, doesn’t apply double materiality across its ratings. In a statement, MSCI said its ESG scores are designed “to support the building of a resilient portfolio for the specific purpose of enhancing long-term risk-adjusted returns. For investors applying double materiality, it added, “MSCI has found that priorities and approaches vary significantly and many prefer to use flexible building blocks that they can tailor to their specific needs over a single combined product.”

S&P Global, on the other hand, said it considers double materiality to be “an integral part of the analysis” when assigning ESG ratings to about 8,000 companies. As a result, ESG scores can vary considerably. Chevron Corp., for example, gets an ESG rating of A at MSCI, and a score of just 52 out of 100 at S&P, according to data compiled by Bloomberg.

Read more: What New ESG Approach ‘Double Materiality’ Means — and Why JPMorgan Is a Fan

The investment industry, meanwhile, remains divided. A September analysis by Morningstar Inc. of the 20 largest asset managers that responded to an ISSB consultation found that eight firms -- all European -- support double materiality. Another six, including Vanguard Group, UBS Group AG and Legal & General Investment Management, would only consider it if a clear financial risk can be established. Five US firms -- BlackRock Inc., Invesco, Northern Trust Corp., State Street Corp. and T. Rowe Price Group Inc. -- want the flexibility to choose.

“It is probably slightly concerning that asset managers on both sides of the Atlantic seem to be so far apart,” said Lindsey Stewart, director of investment stewardship research at Morningstar. “It does give the ISSB and the other regulators around the world a bit of a knotty problem to solve.”

(Adds reference to SEC fighting allegations of agency overreach in policing of ESG fund labels)

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