What do new EU sustainability regulations mean for UK asset managers?

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.