Charles is the Head of Regulation at the Independent Investment Management Initiative.
Although a number of asset managers purport that their investment products embrace ESG (environment, social, governance) principles, EU regulators are now insisting that they be able to prove it. This intervention comes following widespread regulatory and investor concern that some fund managers have been mis-labelling their funds as being ESG-compliant when they are not, a practice otherwise known as greenwashing. In order to put an end to this behaviour, the EU is pushing ahead with its Sustainable Finance Disclosure Regulation (SFDR), which comes into effect from March 2021, and will impose heightened ESG transparency requirements on asset managers.
SFDR in a nutshell
SFDR applies at both an entity and fund level, although larger managers (i.e. those with more than 500 employees) are subject to tougher disclosure requirements. At a firm-level, managers must now provide information on their websites articulating clearly their policies on how they integrate sustainability risks into their investment decision-making process and remuneration practices. At a product-level, there needs to be a pre-contractual disclosure outlining how sustainability risks are factored into investment decisions, along with the potential impact sustainability risks could have on returns. Even if sustainability risks are deemed irrelevant to a product, investment firms must give a comprehensive explanation as to why this is the case. Where firms are promoting ESG products, SFDR will require them to fill in a template in which they mustoutline their sustainability features.
SFDR’s impact will be widely felt
The rules will impact any asset manager currently regulated under the MiFID (Markets in Financial Instruments Directive), AIFMD (Alternative Investment Fund Managers Directive) and UCITS regimes. According to a legal note prepared by Sidley Austin, it also appears that the SFDR (and the Taxonomy Regulation) will simultaneously apply to non-EU AIFMs which are marketing AIFs into the EU through national private placement regimes (NPPRs). “The product-level requirements may also indirectly affect non-EU asset managers that act as delegates of non-EU financial market participants (such as EU AIFMs or UCITS management companies). As such, EU firms are likely to require the information from the non-EU delegate to comply with their own regulatory obligations. That is, a non-EU manager might not have a direct regulatory obligation to prepare the disclosures but might be contractually required by the delegating EU manager to do so,” continued the Sidley Austin briefing.
So what does it mean for UK asset managers post-Brexit? With the UK transition period ending on December 31, EU rules introduced after that date will no longer apply. This will include the SFDR. However, the SFDR is extraterritorial meaning it will affect UK AIFMs distributing AIFs via NPPR. It is also clear that the UK is unlikely to deviate substantially from EU rules, especially if it wants to ensure fund managers can continue to access EU investors in the months and years after Brexit. As a result, most legal experts advise that UK managers prepare for the SFDR or something very similar.
NCI members should be planning for the incoming requirements ahead of their implementation. NCI is conducting a survey of its membership on SFDR, and will be producing a white paper on this topic.