28 July 2021

Latest developments in sustainable finance

1) EU interim ESG developments


 a) EC letter no.1: SFDR 6 month delay now confirmed

Last Friday, ESMA made available on their website the previously leaked letter from the European Commission (EC) to the EU Parliament and Council notifying them of a decision to defer the sustainable finance disclosure regulation (SFDR) level 2 measures of the by six months until 1 July 2022.

As mentioned previously, the EC intent to combine all thirteen SFDR regulatory technical specifications currently in-progress into one single delegated act (DA) as soon as each RTS is completed / adopted.

So, fund firms now have formal confirmation of additional preparation time ahead of their challenging SFDR disclosures (entity / fund level), including those aligned to the Taxonomy regulation (TR).

However, in the absence of a finalised SFDR RTS (i.e. with pending “envisaged amendments” flagged by the EC in their letter): managers remain obliged to comply with their “principles-based” entity and product disclosures for another 11 months (i.e. based on the EC’s original level 1 SFDR legislation as interpreted by each national competent authority).   Which neatly links to the next item…


EC letter no.2: ESAs receive SFDR level 1 clarifications

On Monday (six months later): the EC finally responded to a letter from the European Supervisory Authorities requesting interim clarity on highlighted SFDR priority issues.  In their reply, the EC attach their list of SFDR answers for publication on ESA websites (i.e. to assist firms until 01 July 2022).

While the EC’s 9-page SFDR Q&A responds to each ESA query raised last January, some of the content has reportedly failed to impress prominent industry experts (see section 4. below).

It does appear that some answers relate to different ESA questions.

Here is summary of the more notable interim responses:

  • Registered/sub-threshold AIFMs:
    SFDR entity and product obligations both apply “by analogy”.
  • Non-EU AIFMs (e.g. national private placement regimes):
    SFDR said to apply (but only “product related provisions” are stated).
  • Principal Adverse Impact statement:
    500-employee threshold covers only the parent undertaking of large groups (i.e. unless a subsidiary is also large enough to qualify).
  • Applicability of SFDR products (art. 8, art.9):
    in terms of funds that either promote ESG strategy characteristics [article 8] or pursue sustainability objectives [article 9], the EC do not specify thresholds or percentages to formally establish either product category. They state that both SFDR articles “remain neutral” in terms of “product design… eligible investing styles, investment tools, strategies or methodologies to be employed”.Other clarifications indicate:

    • Art. 8 products: the integration of sustainability risks alone is insufficient for fund to qualify
    • Art.9 products: may include investments for certain specific purposes (e.g. “hedging or liquidity”); however, these also need to “meet minimum environmental or social safeguards” to conform with the overall financial product’s sustainable investments’ objective.
      Moreover, the objective of ‘a reduction in carbon emissions’ is a specific category of ‘sustainable investment’ which should track an EU Climate Transition Benchmark (EU CTB) or EU Paris-aligned Benchmark (EU PAB) where either exist.


c) EC letter no.2: ESAs receive SFDR level 1 clarifications (cont.)

Promotion of products with ESG characteristics: a definition of “promotion” reads as follows:

“by way of example, direct or indirect claims, information, reporting, disclosures as well as an impression that investments pursued by the given financial product also consider environmental or social characteristics in terms of investment policies, goals, targets or objectives or a general ambition in, but not limited to, pre-contractual and periodic documents or marketing communications, advertisements, product categorisation, description of investment strategies or asset allocation, information on the adherence to sustainability-related financial product standards and labels, use of product names or designations, memoranda or issuing documents, factsheets, specifications about conditions for automatic enrolment or compliance with sectoral exclusions or statutory requirements regardless of the form used, such as on paper, durable media, by means of websites, or electronic data rooms.”

  • MiFID II Portfolios and tailored products: The SFDR definition of ‘Financial Products’ makes no distinction to those managed per bespoke client mandate. However, the EC refer to data protection and client confidentiality obligations, stating that “transparency” of those firms promoting “standardised product solutions” “might be a way for complying” with their art. 10 (website ESG disclosures) obligations.

Finally, the EC also includes a section to clarify the SFDR “comply or explain mechanism” (i.e. not directly queried by the ESAs).  They differentiate between:

  • the “comply mechanism” which determines specific “principal adverse impacts” disclosure
  • the “explain mechanism” which requires a clear elucidation of why firms will not consider “adverse impacts” pertaining to sustainability factors in their investment decisions.


d) EC adopts Delegated Act on Taxonomy Regulation (article 8) disclosures

This month the EC also adopted another DA covering the content, presentation and methodology of additional Key Performance Indicators that both non-financial and financial undertakings are required to disclose under article 8 of the Taxonomy Regulation (i.e. not to be confused with SFDR article 8 covered above).  Larger firms classed as public interest entities (PIEs) are now expected to report on initial taxonomy alignment (climate change adaption and mitigation) starting January 2023, with smaller asset managers and investment firms deferred until 12 months later.


2) EU long-term sustainability plans

a) Updated sustainable finance strategy

As mentioned last time, the EC has now launched a new revised Sustainable Finance Strategy.  Updating their 2018 Action Plan, the EC say this represents an “ambitious, comprehensive package of measures to improve the flow of money towards financing the transition to a sustainable economy”.

The EC have now identified four main areas of action ahead for the financial sector:

  1. Financing the transition to sustainability: enabling economic actors reach climate goals
  2. Inclusiveness: opportunities for small / medium firms to have access to sustainable finance
  3. Financial Sector Resilience and Contribution: how the sector will meet their Green Deal targets while combatting greenwashing
  4. Global Ambition: how to promote an international consensus for sustainable finance


Deliverables of interest to Kneip and their clients (within a long list of proposals) include:

  • Social Taxonomy report: Q4-2021
  • A common ‘Double materiality’ perspective method across EU financial system: Q1-2022
  • Digital sustainable finance roadmap: Q4-2022
  • Sustainable financial instruments labelling framework completed by EC: Q4-2022
  • Initiative to make ESG firm ratings “more reliable and comparable”: Q1-2023
  • Consolidated report on EU financial markets’ transition for delivery: Q4-2023

b) Green Deal legislative proposals

The EC also have published their long-anticipated “Fit for 55” package: an updated set of legislative proposals (energy, transport and buildings sectors) to deliver their EU Green Deal interim target of a 55% reduction in greenhouse gas emissions before 2030.  These will directly influence the sustainable finance strategy areas of action.   Again, a long list of EC websites, factsheets, and Q&As are available.


3) UK sustainability latest

a) FCA publish ‘guiding’ ESG principles for UK authorised fund managers
As highlighted last week, the FCA are unhappy with the current high volume of “poor-quality” applications from authorised fund managers (AFMs) attempting to have their new (or repurposed) ESG funds approved for marketing.

Hence, their set of guiding principles to the chairs of UK-AFMs,  calling for consistent application of their funds’ ESG/ sustainability focus as reflected in product design, delivery and disclosure, including:

  1. ESG referral in a fund’s name, promotions or fund documentation should “fairly reflect the materiality of sustainability stated” in the product objectives, investment policy and strategy
  2. Investment strategy to apply consistently with stated ESG objectives (i.e. to be monitored, ongoing). This includes a “reasonable investor” test against a fund’s holdings.
  3. Clear and accessible ESG pre-contractual and ongoing disclosures made easily available to clients (i.e. reflected also in accompanying marketing materials).

The FCA (interim) principles are targeted only at those “funds that make specific ESG-related claims”, i.e. not “those that integrate ESG considerations into mainstream investment processes”.

NB: although similar to the current EEA-SFDR framework, the FCA specify pre-contractual disclosure in both UK-UCITS KIID and UK-PRIIPS KIDs (i.e. both excluded from the EC SFDR level 1 legislation and ESA’s draft level 2 RTSs).   Ongoing, these need to directly reflect the ESG credentials of specific UK products (at the discretion of each AFM) as part of their FCA fund authorisation process.


b) FCA climate change disclosure regime

The FCA guiding principles issued last week are said to “complement” their current proposition to address climate-related disclosure rules for asset managers, life insurers and FCA-regulated pension schemes.

A reminder that the FCA’s consultation (running until 10 September 2021) outlines new proposed measures for asset managers, life insurers, and FCA-regulated pension providers.

Similar again to SFDR, these FCA asset manager proposals cover:

  • Entity-level disclosures: an annual report outlining climate-related risks and opportunities considered during the management of their client investments (i.e. to be signed-off by a member of senior management).
  • 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”. As cited previously, the FCA’s proposed climate change principal adverse indicators differ from the EEA-SFDR regime (with the FCA recommending dual disclosure of both “overlapping metrics”).

The FCA proposed ESG regime is to be initially based on a framework supplied by the Task Force on Climate-related Financial Disclosures (TCFD), whose Proposed Guidance on Climate-related Metrics and Targets (109 pages) and Portfolio Alignment Technical Supplement (75 pages) were recently scrutinised in a separate consultation that ended last week.

The FCA is now expected to issue finalised policy statements in Q4 2021, ahead of a two-phase implementation of their rules (i.e. starting with larger firms managing over GBP 50 billion AUM whose initial disclosures are scheduled from Q3-2023).


c) FCA green taxonomy system

A reminder also that the UK government intends to develop their independent UK taxonomy: i.e. “a common framework setting the bar for investments that can be defined as environmentally sustainable”.

This will refer to the EU equivalent (among others, internationally) and is to be produced by the recently appointed Green Technical Advisory Group (GTAG) whose Terms of Reference is now available.


4) Recent market developments

a) European funds industry: “profound ESG transition” in progress

Investment Week cover Morningstar’s latest Sustainable Fund Flows report, including their prediction that SFDR art.8 and 9 funds could reach 50% of the overall AUM marketplace within a year. Meanwhile, active ESG managers continue to dominate, with passive funds representing only a fraction of assets (i.e. 11% of art.8 products , 10% of art. 9 products) so far.


b) 40% of 2021 fund launches = SFDR art.8/9

FT Ignites also reports on the latest Morningstar research (based on prospectus disclosures),  showing that nearly 40% of new funds launched so far in 2021 are classed as either SFDR article 8 or 9 products.

Most of these are domiciled in Luxembourg (83 launches), way ahead of Ireland (26) and France (17).

In the same piece, separate analysis demonstrates that while 65% of all funds launched in the industry nowadays fail to achieve €100 million of AUM, 60% of those classed as “sustainable” successfully reach this threshold.


c) EC Q&A: market reaction

As mentioned before, the SFDR Q&A issued on Monday seems to have underwhelmed some industry experts. One lawyer deems the EC document ‘provides more questions than answers’ and “super vague”, drawing attention to the complexities now arising from SFDR rules applicable to registered AIFMs.

Elsewhere, another legal firm highlights the Q&A’s broad definition of “promotion” (quoted above) as “unhelpful”.   The European Sustainable Investment Forum (Eurosif) are quoted as saying the Q&A “provides little additional clarity on the classification of products under SFDR”.


d) IOSCO: issues ESG ratings recommendations

Finally,  this week the International Organization of Securities Commissions (IOSCO) started another  consultation, this time covering ESG ratings and data products providers.

Associated challenges and risks in this area are said to include “little clarity and alignment on definitions… including on what ratings or data products intend to measure”, a “lack of transparency about the underpinning methodologies” alongside an “uneven coverage of products offered”.

Accordingly, IOSCO make a series of recommendations (including a need for NCAs to “focus more attention on the use of ESG ratings and data products / providers in their jurisdictions”.

Their report is open for comment until 6 September 2021.

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