By Simon Jessop and Kate Abnett
For money managers and advisers keen to market their sustainable investing credentials to European clients, going green is about to get a lot tougher.
Under a suite of new EU finance rules due to be rolled out in stages, beginning on March 10, firms including fund houses, insurers and pension funds that provide financial products or services in the European Union will have to begin disclosing how sustainable they really are.
The new EU legislation, called the Sustainable Finance Disclosure Regulation (SFDR), aims to help drive 1 trillion euros into green investments over the next decade, iron out the patchy climate-related information currently provided by financial market participants, and give firms with genuinely sustainable products an edge.
“The crucial point is that this covers any entity or financial product,” said Lucien Firth, a partner at law firm Simmons & Simmons. “It doesn’t matter if you market all of your products as sustainable or none of them – it covers all of them.”
The SFDR rules should make it harder for market participants to talk up environmental credentials without following through with action, so-called ‘greenwashing’, and could also determine how big a slice firms can win of the fast-growing market for products with a focus on environmental, social and governance (ESG) issues.
Demand to invest in ESG funds jumped last year, driving assets under management up 29 per cent in the fourth quarter from the prior quarter to nearly $1.7 trillion, according to asset management industry tracker Morningstar.
“Those that already have a good offering in place are going to stand to benefit,” said Alexandra Mihailescu Cichon, executive vice president of sales and marketing at ESG data firm RepRisk.
Set to roll out in several stages over the next two years, SFDR contains reporting obligations at both the company and product level, although investment managers say regulators’ last-minute release of final details of some of the rules is hindering their preparations.
From this week, all funds must disclose in their pre-contractual information how they factor sustainability risks into their investment decisions.
Additionally, those funds promoting environmental or social characteristics, or sustainability objectives, must explain both in their marketing and on their websites the objectives and how they plan to meet them.
Firms must also give an assessment of the main negative impacts their investments will have on the environment and society, or explain why they have not done so. From June, firms with more than 500 staff will be required to report the impacts.
“Any sustainability-related claim by a financial product must be well justified,” a European Commission spokesperson said. National financial market authorities will enforce potential penalties for non-compliance.
Andy Pettit, director of EMEA policy research at Morningstar, said the rules would “go a long way on the greenwashing front… (it will be) much easier to compare different products”.
Within funds, greenwashing could include one that is marketed as ‘sustainable’, but which includes lots of companies with high carbon emissions. The lack of a firm definition of greenwashing means it is often in the eye of the beholder.
From March 10, funds will also begin deciding whether to label themselves as an Article 9, 8 or 6 fund – fully focussed on sustainable objectives; fully or partly focussed on environmental, social issues or sustainability issues; or not focussed on sustainability, respectively – with a hard deadline to do so by the end of 2021.
Article 8 or 9 funds will eventually have to make additional disclosures about what their sustainable objectives are, and from next year report on them against a set of granular sustainability criteria.
Disclosures at a company level will also expand to include data specified by the EU, such as CO2 emissions and water usage across an investment firm’s entire investment portfolio.
Mike Everett, governance and stewardship director at Aberdeen Standard Investments, said his team had analysed all the company’s products, updated pre-contractual documentation, secured regulatory approval and notified clients of the changes.
The company would also publish additional company-level descriptions of its ESG process and policies and details of how the fund managers consider adverse impacts in the investment process.
“These developments require significant effort and management, but are necessary in order to meet the requirements of the regulation,” Everett said.
Many other firms, however, have yet to get to grips with the rules, according to fund servicing firm Apex Group, which pointed to a recent client webinar where just 17% of the audience said they felt fully prepared to meet the rules.
While EU regulators have yet to confirm some of the data that asset managers will need to provide to back up their sustainability claims, there is also concern that some data does not even exist.
Under the EU’s current Non Financial Reporting Directive, for example, smaller companies do not have to provide the same level of data as larger companies on factors such as carbon emissions and boardroom diversity – which could make it tougher for a small-cap fund manager to provide evidence of its portfolio’s sustainability under SFDR.
Given the uncertainty, some investment managers are proving reluctant to commit to labelling themselves as fully sustainable and may wait until later in the year before finally deciding whether to define themselves as an Article 8 or 9 fund.
“Investors are put in a difficult position as (some company)data needed to report on …(the) mandatory indicators are not readily available from their investee companies,” said Anna Hirai, Co-Head of ESG Research at consultants SquareWell Partners.
For Neil Robson, financial services and funds partner at law firm Katten Muchin Rosenman, the greater transparency provided by the new rules should help drive change and potentially expose any lack of action at odds with funds’ green claims.
“Despite the green agenda being front-and-centre in the general media, many fund managers are still following a purely financial, profit-led strategy without any particular ESG focus.”