SFDR: The Starting Gun to the ESG Race

SFDR: The Starting Gun to the ESG Race

White Paper

Background

The European Union has set in motion an ambitious legislative program to make environmental, social and governance (ESG) considerations a central theme of regulation in the financial services industry. This initiative is obviously relevant to asset managers which have an express ESG focus – but key aspects of the incoming regulatory framework will apply to all industry players, even those who do not wish to emphasise sustainability themes in their investment products.

The first set of rules of particular relevance to asset managers came into effect during Q1 2021. However, this is merely the first milestone in a long journey towards the EU’s goal of sustainable and climate-integrated financial services and investment portfolios.

This White Paper takes a closer look at the Sustainable Finance Disclosure Regulation (SFDR) which came into force on 10 March 2021. What is its ultimate goal? What are the challenges? What are the opportunities?

SFDR – What’s in four letters?

Speaking at a recent webinar hosted by ONE group solutions, Nathalie Dogniez (partner and EEA ESG leader at PWC Luxembourg) and Kim-Andrée Potvin (Partner at Bamboo Capital Partners) joined Melanie Hopper and Tobias Ettlin (partners at ONE) to examine the role out and the implications of SFRD for the asset management industry.

The SFDR applies at a product level (e.g. for UCITS, ETFs and AIFs sold in the EU) as well as an entity level (e.g. for UCITS Management Companies, AIFMs and MiFID Investment Firms). It entails ESG-specific transparency obligations that will need to be made to all investors in the product, complemented by disclosures made by the asset managers on their websites. The disclosures require a strategic positioning of these products by asset managers regarding their sustainability approach. They will be required to be transparent about the following: i) sustainability risks, ii) principle adverse impacts (PAI), and iii) classification of the product under SFDR. This is currently done on a principle-basis, but will be enhanced by regulatory technical standards expected during 2021 that contain detailed rules on the content, methodologies and presentation of disclosures.

Opportunities and Challenges

For firms with an explicit ESG focus like Bamboo, SFDR helps to catalyse their sustainable investment objectives. Kim-Andrée Potvin highlighted the fact that the regulation is an opportunity for asset managers to systematise and document ESG considerations. By standardising the disclosure of information, investors will be able to assess and compare financial products more easily. Another benefit will be the reduction of so-called “greenwashing” (asset managers marketing themselves to look more environmentally friendly than they actually are). In the long run, Ms. Potvin believes that this will contribute to transparency and increased trust in ESG products.

Communication and transparency is key for ESG investment products, Ms. Potvin added. SFDR can enhance the clarity of investor disclosures and highlight ESG research and other efforts that asset managers may have been performing for years but couldn’t use to a comparative advantage.

While the market opportunities are undisputed (Nathalie Dogniez quoted a PwC study where a majority of institutional European investors stated that they planned to phase out non-ESG products over the coming years), the efforts expected of asset managers wishing to market their products as sustainable cannot be understated. Ms. Dogniez highlighted the fact that the market has only seen drafts of the regulatory technical standards of SFDR, with the final version expected later this year. This is where things become complex. The European Securities and Markets Authority (ESMA) has defined mandatory metrics for investee companies that are quite intricate. The key challenge will be the sourcing of sufficient data to report under these metrics. Furthermore, managers must determine whether and how each of their products (and not only ESG products) are relevant to principal adverse impacts and to make product level disclosures accordingly.

SFDR – Cui Bono?

Will ESG-driven investors benefit from the SFDR? They will certainly have a lot more information at their disposal, but whether or not there will be enough standardisation in the data to make it comparable is yet to be seen. On the other hand, the cost of implementing SFDR and future ESG measures will be substantial. These costs will have to be passed on to investors. For asset managers, it’s a mixed bag, too. While there are specific market opportunities for verified sustainable investment products, EU-based asset managers are already operating in the most heavily regulated region of the world. SFDR is another burden. At least the European Union is attempting to set out a standardised framework for the implementation and marketing of sustainable financial products. For all its shortcomings, that is commendable. Whether other countries will follow suit to create a level playing field remains to be seen. The EU Action Plan is, to date, the broadest and most comprehensive regulatory initiative developed in sustainable finance and lays out a roadmap for future work to be done. The starting gun to the ESG race has been fired, but the race will be a long one.