The pressure on managers to invest sustainably has been ramping up in recent years as investors become increasingly serious about environmental, social and governance (ESG) issues. A lot of managers have taken note and adapted their processes, and now regulators are increasing the pressure.
The EU’s first stage of Sustainable Finance Disclosure Regulation (SFDR), which comes into force on March 10, is designed to strengthen protection for end-investors. It aims to improve disclosures on the principal adverse impacts of investment decisions and on the integration of sustainability factors within financial products, while also stamping out so-called ‘greenwashing’ of ESG funds.
On our recent webinar “ESG – From Niche to Mainstream: A Regulations & Compliance Roadmap”, Deborah Hutton, head of the asset management and regulatory team at Eversheds Sutherland Ireland, noted there had been some confusion as to what qualifies as an ESG investment and how ESG portfolios are being both developed and marketed to investors.
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“In order to [create] a level playing field across Europe, there is a drive for clarity as to what qualifies as an ESG investment, and how these ESG funds are fulfilling those goals” she said.
Getting ready for SFDR
The scope of SFDR is very wide, covering all EU financial market participants and advisors – as well as non-EU participants that actively market to EU investors. The regulation requires them to start collecting and reporting ESG data, implement policies and make disclosures about how they integrate sustainability risks into investment decisions. If they do not comply with SFDR, then they must explain why and publish a statement on their website and/or during pre-contractual disclosures.
“The crucial point is that this covers any entity or financial product with or without that ESG focus, so it doesn't matter if you market all of your products as sustainable or none of them – it covers all of them,” said Lucian Firth, a partner at Simmons & Simmons.
Just 17% of the webinar's audience said they felt completely prepared to meet SFDR requirements; 60% were somewhat prepared while almost a quarter were not prepared at all.
This suggests there is going to be some "significant scrambling" in the run-up to the March 10 deadline, said William Chignell, chief commercial officer at Apex.
Mr Firth pointed out that some institutions do not even realise they are in scope and they will “need to get their house in order quickly”.
A number of market participants are concerned about how they should comply with SFDR, the "complexities" around knowing what ESG is - and the information that is required to properly measure same, noted Ms Hutton. She explained that there are some intricacies to note together with how to best achieve compliance in the absence of certain details that will hopefully be clarified when Level 2 is finalised and as standards in the market evolve.
The disclosures are split into two levels: the entity level and product level. All entity-level disclosures must be public on the entity's website, and all product-level disclosures must be made during pre-contractual disclosures.
They must also implement a remuneration policy that integrates sustainability risks, and publish this publicly on their website. However, Mr Firth said, “many in-scope entities do not realise they have to do this”.
Firms should also note that from June 30 this year, the adverse impact statements become mandatory for any entity that has more than 500 employees. "So that's no longer comply or explain - they'll have to comply and disclose,” said Mr Firth.
Hari Bhambra, global head of compliance solutions at Apex, noted that outside Europe, “we're seeing globally that a lot of people or institutions are trying to navigate the implications [of SFDR] for them in terms of specifically sourcing capital from EU investors”.
Financial firms that are not in scope of SFDR at all are being progressive and believe it is a good idea to have a policy on ESG risks, said Mr Firth. "They're actually choosing to opt into compliance with regulation, which I think is extremely rare in our industry.”
Future direction of travel
March 10 is just the start date for SFDR and not the finishing line. Stage two of SFDR is set to come into force in 2022 and introduces more detailed requirements from managers than stage one. They will have to stay ahead as the regulation evolves, increases and adapts over time.
Will Wilson, an ESG analyst at Apex, said regulators need to ensure there is a balancing act.
“We want the requirements and metrics to be robust enough to prevent greenwashing, but we don't want them to be so onerous that it steers people to just not comply and explain or to not label their products as sustainable. We want it to be attainable,” he said.
The impact of SFDR on asset managers’ businesses will be significant and could make ESG a key commercial driver.
Ms Bhambra said: “As investors get more visibility of data and the data becomes more comparable, institutions are going to have to start looking at how they operate and what they invest in their own portfolio allocation process in order to be able to continuously evolve. It could become a new commercial driver in terms of how strategies are put together.”
How we can help
We have an entire division dedicated to ESG with expert knowledge of sustainability regulations, rules and guidance being introduced around the world. Our global team delivers a single-source solution and can assist with the development of applicable policies and procedures, including remuneration policies, investment decision making processes/ product governance processes, disclosure policies and ongoing integration of sustainability risks into existing frameworks.
Contact us now to learn more about what we can offer.