1. EU sustainable finance disclosure: legal updates
The European Supervisory Authorities (ESA) consultation on proposed, additional Taxonomy regulation (TR) disclosure rules has now closed. As before, the market now awaits their formal adoption by the European Commission, together with the preceding ESA level 2 RTS Sustainable finance disclosure regulation (SFDR) measures for fund firms. Both are currently scheduled to apply from 01 January 2022.
The EC recently published another ESG Delegated Regulation, this time establishing the technical screening criteria to determine economic activities qualified as contributing substantially to climate change mitigation or adaptation (and those that cause no significant harm to other environmental objectives). These are also currently effective from 1 January 2022, alongside ESMA’s pending RTS on “social and employee matters”; this information is required to enable firms conduct a formal (“rules-based”) assessment of their principal adverse impact (PAI) on sustainability factors next year.
Latest (reliable) industry sources now indicate the EC are unlikely to announce their adoption of the ESA’s collective SFDR / TR measures until early-July. The EC has yet to formally respond to the ESA’s previous request for interim clarity on highlighted SFDR priority issues.
While EFAMA has welcomed the EC’s recent decision to stagger a separate set of sustainability disclosure measures for larger public interest entities, they remain convinced that a SFDR / TR 2020 transition period is of key importance to overcome the listed concerns of their members.
In the shorter term: those larger fund firms with more than 500 employees have until 30 June 2021 to issue their initial PAI statement (i.e. “principles-based”) at entity level.
2.UK ESG developments
The Financial Conduct Authority (FCA) has issued new proposed climate change disclosures facing:
Both sets of measures are aligned with the UK Government’s local “2025” roadmap based on the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD). Similar to SFDR, the FCA asset manager proposals cover:
- Entity-level disclosures:an annual TCFD report outlining climate-related risks and opportunities considered during the management of their client investments
- Product / portfolio-level disclosures: an annual “baseline set of consistent, comparable disclosures in respect of their products and portfolios”, including “a core set of metrics”.
FCA consultations run until 10 September 2021, with finalised policy statements expected Q4 2021.
Meantime, the FCA have outlined a two phase implementation of their rules:
- 01 January 2022:firms managing GBP 50 billion AUM (or owning more than GBP 25 billion AUM)
- 01 January 2023:all remaining firms (e. above a set GBP 5 billion AUM threshold)
Respective publication of initial disclosures are required 18 months after the regimes come into force.
NB: the FCA paper contains a comparison of differing TCFD and SFDR calculation methodologies, with a proposal that firms should report in accordance to both regimes.
Elsewhere, the UK Government has confirmed their creation of an advisory group to create a new local “green taxonomy” system as they indicate further post-Brexit divergence from the EU legislation.
3.Recent market developments
a) Capital Monitor: EU rules raise greenwashing risks for sustainable funds
“A lack of technical guidance on Europe’s SFDR legislation has left asset managers to fill in the gaps, leading to confusion and serious risks of both greenwashing and market fragmentation.”
Prior to March 2021, products labelled “sustainable” were said to total EUR 11 trillion.
It remains difficult to obtain an accurate depiction of the post-SFDR (level 1) funds marketplace, i.e. in terms of all European products now classed as “article 6” (deploying no sustainability into the investment process), “article 8” (promoting ESG characteristics) or “article 9” (directly targeting sustainable investment objectives). With information still sketchy in some countries, we understand reliable industry indicators and supporting analysis are likely to appear in Q3 2021.
Meanwhile, Capital Monitor (a recently launched UK-based sustainable finance media website) have conducted a survey of 30 asset managers using Morningstar data. Noting scarce formal guidance currently available (and “widely varying” approaches), they observe some firms have already SFDR-classified a large majority of their products, while others remain far more cautious.
Latest results indicate that around 24% of all EU domiciled funds (EUR 2.5 trillion AUM) have been classified as SFDR article 8 or 9 funds. However, there are now widespread concerns (including from regulatory insiders) that some funds are currently misclassified for interim “communication and marketing purposes”. There are also worries that pending level 3 SFDR / TR guidance (from national competent authorities) may risk “considerable market fragmentation” in due course.
b) Fund firms face up to SFDR level 1, 2 challenges
Several notable asset managers (speaking at a recent Luxembourg webinar) currently anticipate “ballooning” disclosures next year (including a 700% increase in fund documentation word count) when the aforementioned level 2 SFDR / TR measures becomes applicable.
Similarly, the international consultancy firm Alpha FMC point to “very prescriptive” regulatory technical standards and increasingly high volumes of “inconsistent” ESG data now causing “pain” for fund governance teams. They have also examined SFDR data transformation / technology requirements separately (including a short video).
c) SFDR: “Transparency not enough”
“The EU’s current approach to SFDR is like putting words in the dictionary but not including what they mean”
Eurosif (quoted per previous article) are a prominent Belgium-based sustainable trade association. In their latest letter to the EC, they cite the need for “Coherent, Effective and Impactful sustainable finance policies”, for the EU financial system to convey “strong price signals to the real economy” and a ‘double materiality’ ecosystem and reporting framework that “goes beyond the international minimum common denominator”.
d) IF conference discussesSFDR article 8 “confusion”
“Article 9, in terms of the guidelines, was easier to frame… but article 8 we found very, very challenging.”
Finally, participants at the recent Irish Funds annual conference highlighted “widespread confusion” surrounding exactly what constitutes an SFDR article 8 product. Firms also observed “increasing commercial pressures” arising from the evolving ESG funds regime, including client demand for more article 8/9 products, “greenwashing” avoidance and the importance of “balancing reputational risk”.