One year on: Has SFDR succeeded in changing the industry’s sustainability credentials?
The EU’s sustainable investment regulation has successfully started to install rigour into the market for ESG products, but the task is far from complete.
When the European Union’s Sustainable Finance Disclosure Regulation (SFDR) came into force on March 10 last year, the financial services industry, already besieged by seemingly unending reporting requirements, collectively held its breath.
In recent years, the combination of increased public demand paired with an easily understandable umbrella term rocketed ESG to the fore, hitting the headlines and spawning countless product launches.
“Investors’ mindsets towards sustainable investing had already matured past pure altruism, recognising that environmental, consumer and regulatory needs had aligned in a manner that cast ‘green’ as the new ‘growth’,” says Will Wilson, ESG Assistant Vice President, Climate Lead at Apex Group. “Following investors’ lead, the Private Equity industry put renewed energy into an area that had previously been considered niche.”
The speed of this transition opened up ESG, and what defines an ESG product, to interpretation. In some cases, it has also opened it up to opportunism.
Enter SFDR which, among other things, was tasked with improving the disclosures and transparency of ESG offerings. It affords investors a clearer understanding of their impact and counters attempts to ‘greenwash’ unsuitable products as environmentally sound.
So, one year on from its introduction, how has SFDR fared?
Its first tangible impact harked back to ESG’s forerunner – ethical, or dark green, investing – in that it negatively screened the industry for holes in their sustainability credentials. It resulted in the European ESG market decreasing by circa £2 trillion last summer.
This enforced exodus seemingly laid the groundwork for data provider Morningstar to purge its European sustainable investments list, which it did last month, removing over 1,200 funds, with combined AUM of $1.4tn.
Morningstar noted that it had found “ambiguous language” within the legal fillings of these funds, many of which had been classified as Article 8 under the SFDR (those that promote positive environmental or social characteristics).
The next phase of SFDR disclosures has been repeatedly delayed, affording asset managers with additional time to acquire the data necessary to satisfy Principle Adverse Impacts reporting, which looks at the negative sustainability factors linked to an investment.
Herein lies the challenge for the industry. Technical environmental data is certainly available, however interpreting and collating this in a time-efficient and accurate manner remains difficult.
“Climate-related metrics, like greenhouse gas emissions, have emerged as the most widely sought-after data points for investors and regulators alike,” Will Wilson says. “From a Private Equity perspective, they are relatively easy to compile, owing to the greater engagement channels and access associated with the asset class. For public market fund managers, a more nebulous, top-down approach awaits, which is fraught with challenges relating to accuracy and repeatability.”
Although it has been a steep learning curve for the industry, SFDR has had its successes. It has weeded out some of the pretenders and is upholding stricter standards for those products that remain eligible. However, it has not all been plain sailing.
One area of uncertainty involves the EU Taxonomy Regulation, and how it will interact with the conditions outlined in SFDR. To combat this, a single rulebook melding the sustainability disclosures of the two programmes is being produced.
Private Equity funds will be under pressure to appease both; aligning with Article 8 or higher under SFDR, while meeting the environmental objectives outlined by the Taxonomy.
As level two disclosures loom, the industry will face more of these challenges, further pressurising precious resources and creating pinch-points within companies.
The range of tools offered by Apex Group, including our ESG Ratings and Reporting, Carbon Footprint Assessment and Invest Check functionality, may alleviate this strain, empowering firms to allocate more time to the ‘day job’ and, in turn, their clients.
Find out more about our ESG advisory services and contact us with any questions.