Top 10 ESG developments for asset managers

The growing importance of ESG matters has meant considerable changes for asset managers. At EU level, the European Sustainable Finance Disclosure Regulation (SFDR) has applied since March 2021. SFDR requires the disclosure of how asset managers integrate sustainability risks and factors into the investment process.

SFDR goes hand in hand with the EU Taxonomy, which is another recent European regulation, this time aiming to create a system by which economic activities can be classified as “environmentally sustainable”.

At UK level, we are also seeing an indication of the outline of the post-Brexit ESG framework for UK asset managers.

We set out the top 10 2021 regulatory developments for asset managers under the following categories: SFDR preparation and organisational requirements for EU asset managers; UK post-Brexit ESG framework; and ESG data quality and greenwashing.

This will likely become increasingly important for the asset management industry, particularly following COP26, which is currently being held in Glasgow.

SFDR preparation and organisational requirements

1) SFDR templates published

In February 2021, the ESAs issued a report containing guidance on the format of disclosures under SFDR. This includes a standardised format for entity-level reporting under article 4 of SFDR, generally known as the Principal Adverse Sustainability Impacts Statement; and a mandatory disclosure template for pre- contractual disclosures and for periodic reports of funds promoting environmental or social characteristics (article 8 “light green funds”) and funds that have sustainable investment as their objective (article 9 “dark green funds”). In March 2021, the ESAs published a joint consultation paper on the proposed changes to existing RTS and the format of disclosures to be made by asset managers under the SFDR, as well as RTS, under the Taxonomy Regulation.

The aim is for these templates to provide standardised disclosures which can be easily understood and compared against each other for article 8 (funds which promote environmental or social characteristics) and article 9 funds (funds which have sustainable investment as their objective). These templates will need to be used by in-scope asset managers where funds are either EU funds or marketed to EU investors.

While the templates are not yet finalised, in-scope asset managers should use best efforts to provide the type of information set out in the publications until such time as the RTS enter into force (they have already been delayed (see point 4 below)).

2) ESA letter to the European Commission calling for clarification on the SFDR

In July 2021, the European Commission published an internal Commission Decision an annex in response to a letter from the ESAs asking for clarity in relation to aspects of the SFDR. These include: whether non-EU AIFMs would need to comply with SFDR by virtue of article 4(1)(b) of AIFMD (which captures non-EU AIFMs); the application of the 500-employee threshold for principal adverse impact reporting on parent undertakings of a large group; what will and will not constitute an article 9 product; and the meaning of “promotion” in the context of article 8 products promoting environmental or social characteristics.

The European Commission’s response is helpful in some, but not all, areas and further questions remain.

3) ESAs’ supervisory statement in relation to the SFDR

In February 2021, the ESAs published a supervisory statement providing that asset managers and national competent authorities should “refer” to the draft RTS of the final report submitted to the European Commission in February 2021 for the purposes of applying the provisions of articles 2a, 4, 8, 9 and 10 of the SFDR in the period between 10 March 2021 and the application date for the RTS (which have not yet been adopted by the European Commission). The statement also includes an annex containing specific guidance on the application of timelines of some specific provisions of the SFDR (e.g. the application timeline for entity-level principal adverse impact disclosures and for financial products periodic reporting) and a summary table of application dates, which asset managers may find helpful.

4) European Commission confirms delay to application date of EU SFDR RTS

In July 2021, the European Commission published a letter, confirming that delegated regulations under the EU SFDR (described at point 1 above) on ESG disclosures for asset managers will be condensed into one delegated regulation containing all relevant RTS. It also confirmed that some rules that were due to apply from 1 January 2022 will be postponed until 1 July 2022.

This gives firms additional time to make preparations to ensure that they can comply with SFDR disclosure templates.

5) ESG delegated acts amending AIFMD, UCITS and MiFID II finalised

In August 2021, a number of ESG delegated

acts amending MIFID II, UCITS and AIFMD were published in the EU Official Journal. These cross-refer to the SFDR and impose additional requirements on asset managers.

Under the delegated regulation amending AIFMD, AIFMs will need to take into account sustainability risks when complying with general requirements; ensure that senior management is responsible for the integration of sustainability risks into investment processes; consider the types of conflicts of interest arising in relation to the integration of sustainability risks and factors (e.g. greenwashing, mis-selling and misrepresentation of investment strategies); and, in addition to existing requirements relating to due diligence, consider sustainability risks when selecting and monitoring investments, designing written policies and procedures on due diligence, and implementing effective arrangements.

The delegated act amending AIFMD applies from August 2022. While this may feel like a long way off, some considerable work is required in order to ensure compliance with the delegated regulation before then.

UK Post-Brexit ESG Framework

6) FCA consultation on extending climate-related disclosure requirements to asset managers

In June 2021, the FCA issued a consultation paper setting out proposed rules in relation to disclosures required to be made by some UK asset managers in line with the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD). UK asset managers would need to make an annual sustainability disclosure report in respect of an entity’s sustainability profile covering governance, strategy and risk management; scenario analysis; and metrics and targets. At product level, a UK asset manager would be required to make an annual sustainability disclosure report in respect of its products/portfolios.

A policy statement on these proposed rules should be published shortly. Although, since many larger UK asset managers already provide TCFD reports, the new rules may not be overly burdensome.

7) UK Taxonomy: Green Technical Advisory Group

In June 2021, the UK Government provided further confirmation that the UK would be developing its own framework for determining whether investments can be defined as environmentally sustainable. The UK announced that it had set up the Green Technical Advisory Group (GTAG), which will oversee the Government’s delivery of the UK’s “Green Taxonomy”. The UK had previously indicated that it would establish its own UK Taxonomy by the end of 2022 and this publication represents a significant step towards that goal.

8) FCA guiding principles on ESG and sustainable investment funds

In July 2021, the FCA published a Dear Chair letter addressed to the chairs of authorised fund managers (AFMs) on improving the quality and clarity of authorised ESG and sustainable investment funds. The letter was issued as a response to FCA concerns about poorly drafted and substandard applications for authorisation of investment funds with an ESG or sustainability focus.

The annex to the letter sets out guiding principles for consideration when an authorised investment fund pursues a responsible or sustainable investment strategy and claims to pursue ESG or sustainability characteristics, themes or outcomes. The letter provides action points for AFMs such as in relation to the names and investment strategies of ESG-focused funds; documentation and periodic reports in respect of ESG-focused funds; and existing arrangements for sourcing and using ESG data.

There are a number of similarities between the letter and the SFDR, even though the UK has not onshored the SFDR, and the letter arguably implements parts of SFDR with regard to UK authorised funds. The letter probably gives an indication of what’s to come in the UK in relation to the SFDR and will be of interest to both authorised and unauthorised fund managers.

ESG data quality and Greenwashing

9) ESMA letter on ESG ratings and ESG data providers

In January 2021, ESMA issued a letter regarding ESG data providers. This is particularly relevant to asset managers who need to demonstrate how they take ESG factors into account in investment processes and risk management processes. There has been concern in the industry about the quality of ESG data provided by service providers. The letter calls for a common legal definition for ESG ratings so that all existing product assessments regarding the ESG profile of an issuer/security are subject to safeguards, and states that ESG rating providers should be subject to stringent measures to ensure that ESG ratings and assessments are based on up-to-date, reliable and transparent data sources, and that methodologies are transparent.

This is an area to watch and is likely to develop in the same way for ESG rating providers as we have seen for credit rating agencies.

10) Renewed sustainable finance strategy

Finally, in July 2021, the European Commission published the renewed sustainable finance strategy. Although the proposals are a long way from being concrete requirements, they give an indication as to the critical next steps in EU ESG legislation and contain important proposals that will be of interest to asset managers. Proposals include: looking at ways to boost the existing supervisory and enforcement powers of competent authorities to address greenwashing; a general framework for labels for financial instruments; minimum sustainability criteria for financial products that promote environmental or social characteristics under the SFDR; a proposal for a Corporate Social Responsibility Directive to require large listed EU companies to disclose “meaningful, comparable and forward-looking sustainability data across the finance value chain”; and action by the European Commission to strengthen the reliability and comparability of ESG ratings by Q1 2023.

Authors: Lorraine Johnston (Partner), Bisola Williams (Expertise Legal Manager)