Skip to main content

Fund managers need to prepare for sustainable finance disclosure

Back Arrow Back

Fund managers need to prepare for sustainable finance disclosure

New EU regulations on sustainable finance and associated investor expectations pose challenges for fund managers. Senior Consultant - UK Fund Services, Melville Rodrigues considers what they need to do. *

Sustainability and responsible investment are becoming mainstream priorities for pension funds, insurers and other investors. Managers are responding with fund products that look to meet these priorities.
At the same time, managers must get ready for regulation (and associated investor expectations) focused on sustainability‐related disclosure: regulations aimed at identifying the adverse impacts of investments on sustainability, ensuring credibility of sustainable investments and increasing awareness about sustainability risks.
This article considers the following EU regulatory initiatives: 

  • Sustainable Finance Disclosure Regulation (SFDR), which will take effect on 10 March 2021.
  • Taxonomy Regulation, which has entered into force but has core provisions applying from 2022.

SFDR scope

The SFDR requires fund managers, such as those operating as alternative investment fund managers (AIFMs), as well as others within the financial services market, to disclose how they have integrated in their processes, including in their due diligence (DD), an assessment of all relevant sustainability risks that might have a material negative impact on the financial return of a fund investment. This will be detailed in the SFDR regulatory technical standards (RTS), in which managers will need to quantify or describe principal adverse impacts associated with sustainability risks. It is expected that the European Commission will confirm the RTS during 2021, with the RTS themselves coming into effect in early 2022.  

In relation to fund products to be marketed within the EU after 10 March 2021, EU AIFMs, as well as non-EU managers marketing products to EU investors, should ensure SFDR compliance with the marketing of the products. Additionally, there may be an extra-territorial market effect with non-EU investors being attracted by and adopting the SFDR disclosure benchmarks for DD purposes when looking at prospective fund products. Investor expectations, and managers strategically opting to adhere to best practice benchmarks, may result in more extensive manager compliance with SFDR principles.

Comply or explain

Manager level
Managers must formulate a policy on integrating sustainability risks in their investment decision-making process. Managers must also decide on either:

  • Implementing a DD policy relating to the “principal adverse impacts” (deleterious effects of investment decisions on environmental and social criteria) of its environmental, social, and governance (ESG) investment decisions.
  • Explaining why they do not consider the principal adverse impacts to apply. 

Managers must also:

  • Update their existing remuneration policy to include information on how the policy is consistent with integrating sustainability risks.
  • Include on their websites a description of their policies with respect to how sustainability risks are integrated into the investment process and remuneration practices.

From 30 June 2021, managers with more than 500 employees must disclose (that is, they are not entitled to rely on the comply or explain regime) principal adverse impacts on their websites and summaries of engagement policies. Whereas, managers with fewer than 500 employees can continue to rely on the comply or explain regime.

Product level
All managers will have to articulate how their sustainability risk policies impact their products. Specifically, they must either:

  • Assess the likely impacts of sustainability risks on their products’ returns.
  • Explain why they consider sustainability risks not to be relevant to their products.

From December 2022, managers must also disclose whether and if so, how they consider principal adverse impacts for each of their products. If the managers do not consider principal adverse impacts, they must explain for each financial product the reasons why they do not consider principal adverse impacts to apply.

Article 8 and 9 products
Products covered by Articles 8 and 9 of the SFDR are essentially financial products that are held out as being sustainable. Each manager will be required to:

  • Review its marketing documents, and ensure that documents do not contradict SFDR mandatory disclosures.
  • Assess each product, and if applicable, make additional product disclosures with reference to the following SFDR articles:

          - Article 8 product (promotes environmental or social characteristics). Information on how those characteristics are met and (if there is a relevant index) information on whether and how this index is consistent with those characteristics.

          - Article 9 product (has sustainable investment as its objective). Information on how sustainable investment objectives are achieved and (if there is a relevant index) information on how the index is aligned with that objective and an explanation as to why and how the index differs from a broad market index.

The manager will need to implement pre-contractual disclosures for Article 8 and 9 products.
Interlinked Taxonomy Regulation 
The Taxonomy Regulation is aimed at introducing a benchmark for environmentally sustainable economic activities and to prevent greenwashing, that is, investments that do not meaningfully address “E” or “S” issues.
Managers marketing a fund with environmentally sustainable credentials must on a staggered basis from 2022:

  • Comply with such criteria and minimum safeguards (to be set out in future legislation).
  • Demonstrate that the fund does not cause harm to six environmental objectives:

          - climate change mitigation;
          - climate change adaptation;
          - sustainable use and protection of water and marine resources;
          - transition to a circular economy;
          - pollution prevention and control; and
          - protection and restoration of biodiversity and ecosystems.

  • With reference to the dates and environmental objectives below, disclose which objective(s) the product contributes to and to what extent its underlying investments qualify as Taxonomy Regulation-compliant:
  • January 2022: climate change mitigation or adaptation.
  • January 2023: any of the remaining four objectives.

UK and Brexit dimensions

The UK government has announced that the UK will implement:

  • fully mandatory climate-related financial disclosures across the economy by 2025 (with many disclosures coming into force by 2023), going beyond the “comply or explain” approach.
  • a green taxonomy, a common framework for determining which activities can be defined as environmentally sustainable, which will take the scientific metrics in the Taxonomy Regulation as its basis.

In the context of the UK legislation, there will be an FCA consultation about implementing associated rules in its Handbook. EU SFDR-related legislation may not strictly apply to UK managers from March 2021, unless the managers operate via an EEA AIFM and/or wish to market fund products into the EEA. Furthermore, as indicated above, UK managers may opt to adhere to best practice benchmarks based on EU financial disclosure legislative principles.

Need to prepare

Fund managers must consider the implications of the SFDR and the taxonomy regulation, and (as appropriate) similar UK legislation. In the context of compliance, managers should progress preparations including with their investment procedures and efficient solutions to gather and report on ESG data. Strategically, managers need to recognise the reputational and other positives – albeit balanced with additional operational costs – of embracing the challenges of sustainable finance disclosure.

To discuss how Ocorian can support your real estate fund operations, contact Melville below.

* Article first published on Thomson Reuters Practical Law December 2020 

You may also like

04 December 2020

Reading time: 2 minutes

Post-Brexit funds landscape is clearer

With the marketing of funds between the UK and the EU set to continue, London will remain a funds ...

Read more

03 December 2020

Reading time: 5 minutes

Case study: Financial structuring for commercial real estate

Executive Director, Nick Terry presents a case study to highlight how appointing an independent re...

Read more

30 September 2020

Reading time: 7 minutes

Strategic solutions for UK real estate fund managers post-Brexit

Melville Rodrigues, Senior Consultant - Fund Services suggests strategic solutions for UK real est...

Read more