The Sustainable Finance Disclosure Regulation (SFDR), which came into force in all EU member states in March, is part of a new wave of legislation designed to strengthen the financial sector’s role in making business more sustainable.
It’s likely to be a disruptive force across the EU, obliging a broad range of organisations participating in the financial markets to publish more information about their environmental, social and corporate governance (ESG) performance. But the regulation also has significant implications for players in the UK, as its requirements apply to any non-EU-based asset manager that deals with EU investors.
Under what scenarios might operators in this country be affected by its provisions – and how? How best can they prepare for such changes? And should we expect a version of the SFDR to make its way into the UK statute book too?
The overriding aim of the SFDR is to crack down on greenwashing and protect investors by creating a clear framework under which products can be compared. In simple terms, the regulation requires asset managers and financial advisers to demonstrate their ambitions towards, and engagement in, ESG, putting the onus on them to collect ESG data and report on this. They must also share how they plan to integrate the associated risks into the investment choices they make.
The need to publish this information isn’t reserved to ESG funds either, although those funds that promote environmental and social characteristics (article-eight funds) and those that have sustainable investment as their key objective (article-nine funds) may be required to make additional disclosures.
“While fund managers have been quick to communicate externally about their ESG credentials, the SFDR brings in stricter standards about what counts as sustainable and what does not, putting them in front of their responsibilities and making them accountable.” So says Georgia Stewart, CEO of Tumelo, a fintech firm that works with asset managers such as Aviva Investors and Legal and General Investment Management to help them fulfil their ESG commitments.
“Pension and retail investors hold trillions of dollars in funds. As a result, fund managers control majority stakes in many of the world’s most influential companies,” she adds. “Investors want these companies to change, but they have no voice. Fixing this breakdown of shareholder democracy would create massive opportunities.”
Victoria Gillespie is responsible for sustainability and ESG services at JTC Group, a provider of fund management services based in Jersey. She warns that, although the SFDR came into force after the end of the Brexit transition period, there are still plenty of circumstances in which UK organisations could be subject to its obligations.
“UK managers marketing funds to EU-based investors and those that provide portfolio management services to EU managed funds will be affected to some degree,” says Gillespie, but she adds that the regulation is “complex”, with the more detailed technical requirements set to be implemented in a second phase next year. In other words, “there will be a learning and adjustment period for those making the first disclosures”.
How well prepared are UK asset managers and financial advisers for the new requirements? “There is a very mixed picture,” reports Richard Burrett, chief sustainability officer at Earth Capital, a London-based fund specialising in cleantech investments. “Some larger players are already collecting data that will enable them to make selected funds compliant with SFDR. But many others are unready – and the reporting obligations are not trivial.”
He continues: “In addition, some managers are reportedly staying away from the article-nine fund declaration because they want to avoid the reputational damage of a potential downgrade later, as some of the standard’s definitions remain imprecise.”
Iain Ramsay, chief investment officer at AHR Private Wealth, notes that a “key hurdle for investment firms will be creating the necessary framework and management processes to comply with the chosen level of the regulation. For some, this may require investment in resources and infrastructure to demonstrate selection criteria, as well as monitoring and adoption of the chosen ESG focus. There is, of course, a significant time and cost to this process. Firms will need to develop a clear implementation strategy to achieve a smooth transition.”
Alongside all these considerations is the possibility that the UK may write its own version of the SFDR. After all, as well as signalling its intent to make the requirements of the Task Force on Climate-Related Financial Disclosures mandatory for all large companies by 2025, the government has created an independent Green Technical Advisory Group in a bid to curb greenwashing. The Financial Conduct Authority has even published a consultation paper on climate-related financial disclosures for asset managers.
These developments are all “indicators that the UK is pushing environmental factors to the forefront of its agenda”, Gillespie says.
Stewart agrees. “There is certainly momentum in the run-up to the United Nations’ COP26 climate conference. I hope this will provide an opportunity for policy-makers and the financial services community to meet and find a way to work together to deliver a positive impact,” she says, adding that the UK could go a step further than the EU and require asset managers labelling their funds as article eight or article nine to “commit to full transparency”.
There is undoubtedly scope for the UK to adopt its own version of the SFDR or create a “better-defined disclosure standard”, according to Burrett. “But that might add to the administrative burden of British firms wishing to meet both standards.”
He may well be proved right. What’s abundantly clear right now is that the SFDR will have a sizeable impact on the UK’s asset management industry – one for which all fund managers and financial advisers must prepare.