By: Andy Pitts-Tucker, Managing Director, Apex Group ESG Ratings & Advisory
The ESG bull run is exciting news for people and planet, and is fast becoming embedded both in mainstream thinking and regulation, however the source of a lot of the confusion and aggravation with ESG is often the lack of consistency among reporting and disclosures. The EU’s recent response to this uptick in inconsistent practices is to level the playing field with its Sustainable Finance Disclosure Regulation (SFDR) and Taxonomy Regulation.
The SFDR requires financial market participants (FMPs) and financial advisers (FAs) to consider sustainability risks across various aspects of their operations, including disclosures, integration into policies including remuneration policies, risk policies, investment process, product governance and wider internal processes and systems. The EU Taxonomy sets out a classification system for all economic activities regarding their contribution to sustainable objectives, specifically focusing on environmental objectives.
The two regulations come with the aim of setting a standard across the market to credit genuinely sustainable economic activity while curtailing greenwashing. In doing so, the SFDR has effectively set up labels for financial products which are named after the relevant articles in the regulation that they adhere to. An ‘article 9’ (or ‘dark green’) financial product is one that adheres to the requirement that it pursues a ‘sustainable investment’ objective, while an ‘article 8’ (or ‘light green’) financial product is one that ‘promotes environmental or social’ characteristics. Article 6 of the SFDR requires all FMPs and FAs to disclose their monitoring (or lack thereof) of sustainability risks and so is the catchall clause applied to all other products (or ‘brown’ products) that don’t fall under the other two articles.
The SFDR is yet another strong indicator that ESG is here to stay, and that its influence will continue to grow. The SFDR’s scope is enormous; not only as a mandate over all EU financial products but over any other non-EU products that wish to actively market into the EU. With such a wide-ranging scope, the SFDR should be viewed as a great opportunity to demonstrate credibility and transparency to investors.
However, the SFDR is not without its challenges, and the broad scope means some products can fall through the cracks. One crucial aspect is the delayed publication and adoption of the SFDR’s Regulatory Technical Standards (RTS). These are the specific guidelines for FMPs and FAs to follow to make sure their products are in line with their desired label. Although the European Supervisory Authorities (ESAs) have advised everyone to get to work using the RTS, they are only available in draft form and have not yet been confirmed. Any significant changes to the draft RTS could cause considerable disruption and the ESAs have already suggested a six-month grace period to allow FMPs to react.
The uncertainty of timelines is one of the many challenges posed by the SFDR, since the pandemic and economic downturn have understandably waylaid proceedings. The issues deepen when the details of the draft RTS fail to provide solid guidance for a variety of products, for example: funds-of-funds, multi-asset funds, government-bond funds. This part of the SFDR is a sore spot that has been raised multiple times, both in the ESAs public consultation and EU Member States’ review.
If a fund-of-funds is EU-based or actively markets into the EU, it will need to be SFDR-ready. However, the complexities behind this task are substantial and are not made easier by the lack of legislative clarity. A fund-of-funds can often lack the prerogative to request from their investments the kind of in-depth data that articles 8 and 9 demand, especially when trying to ‘look through’ to the ultimate underlying portfolio companies and investments of the funds.
The challenges of the SFDR could have serious consequences. If a fund-of-funds aspires to article 8 or 9 status but cannot obtain the necessary data from an investment, it is left with a choice to divest or face losing that status. This presents a testing predicament since a fund-of-funds with incomplete disclosures may struggle to attract as much investment, as investors seek to align themselves with article 8 and 9 products. Indeed, many asset managers and investors have shown in recent months that divestment and shareholder activism are tools they are not afraid to use.
Reliable data is the foundation of the SFDR, and fund managers are seeking to ensure that their disclosures, and the data behind them, are reliable and accurately reflect the ESG position and mandates of their funds. At Apex ESG, we believe that quality ESG data capture is one of the cornerstones for ensuring risk mitigation and sustainable returns for investors. Our dynamic ESG platform, which hosts client- and sector-specific products, forms the basis of the data collection process that is relevant, rigorous and easy-to-use.
Though the challenges of the regulatory landscape would make one think the next step is for funds-of-funds to embark on their SFDR journey sooner rather than later, the uncertainty and lack of guidance from the draft RTS have added an air of hesitancy. At Apex ESG, our Invest Check product aims to counter these issues by collecting, consolidating and reporting ESG data both within and across funds in a report aligned to the SFDR template, streamlining the submission process for you, and getting ahead of the scramble for compliance.
Invest Check assesses the investment strategy, tracks performance and key gaps of any fund manager against a dataset based on the key regulations, like SFDR, and a wide range of ESG standards such as TCFD, UNPRI, and many more. It therefore can be used by fund-of-funds managers to collect and report on the information required by SFDR across their different fund investments, while comparing each manager’s ESG approach against best-in-class standards and their peer groups.
For those fund-of-funds managers that are more ambitious and want to ‘look-through’ to the underlying assets of every manager they invest in, Apex ESG can provide a wholly integrated solution. All via our smart, web-based platform, a fund-of-funds manager can assess not only the managers they invest in but can receive the latest data from the assets too. This complete vertical integration can work through managers deploying either our ESG Rating, Health Check, Real Estate Check, or Carbon Footprint products. Each product enables underlying assets to report through multiple levels of investment, alongside receiving expert guidance and advisory services tailored to them.
This complete integration of ESG reporting for fund-of-funds is unique and market-leading. Not only does it satisfy all current regulatory needs but also enables fund-of-funds to craft investment strategies that are fit for any future legislative developments. The SFDR is only the beginning of regulation that requires investment managers to understand and disclose the sustainability risks and impacts of their investments. In the US, the SEC have recently closed their public consultation on climate-related disclosures and the early signs point to stakeholders hoping for significant overlap with equivalent EU regulation.
At Apex ESG, we constantly monitor the regulatory landscape to keep our platform dynamic and up to date, ensuring our clients are never playing catch-up. By deploying intelligent ESG data and insights, we aim to help our clients successfully navigate regulatory demands and fulfil their ESG goals, thus being able to authentically position themselves as progressive and forward-thinking in this fast moving ESG world.
About the author
Andy Pitts-Tucker is Managing Director, Apex Group ESG Ratings & Advisory, Founder of PT Conversation and Development Board Member of Tusk Trust.