With less than a week until the SFDR reporting deadline, client advisers and asset managers in Luxembourg and internationally are gently testing the water. From how to classify different funds and what to report to investors, the financial industry is progressing with caution.
From next Wednesday 10 March, the EU’s Sustainable Finance Disclosure Regulation (SFDR) will require asset managers to notify their environmental, social, and governance (ESG) stance at an entity and product level. This must be done without the EU level regulators having issued clear rules, and nor can there be any indication how existing rules will be interpreted.
Dialogue
‘Our intention is to deepen the dialogue with our clients on ESG risks and opportunities related to investments,’ noted Olivier Goemans, Head of Investment Services and Innovation at the Banque International à Luxembourg (BIL) when asked how they are navigating the lack of clarity. ‘We want our clients to understand how their investments can help change things and contribute to a sustainable economy,’ he added.
‘Regarding the selection of external funds, we rely on our long-term internal expertise featuring due diligence, internal non-financial indicators and scoring to select the best ESG funds,’ said Laurent Simeoni, Head of Portfolio Management at ING Luxembourg. ‘Using ESG products is also the rule now for our discretionary mandates, and we already converted nearly half of our model portfolios using our internal ESG selection model,” he said. ‘It is a journey of learning-by-doing that we have been on for a while,’ said Goemans. ‘It is calibrated in accordance with feasibility, operability and client appetite.’
Strong demand
The latter seems clear, with a step change apparently having taken place in recent years, driven by both retail and institutional investors. In a recent survey by US investment firm Cambridge Associates, the number of institutional investors that report making sustainable and impact-related investments has increased by 146% since 2016. 61% of the 202 respondents are actively engaged in sustainable, impact or ESG investing, an increase of 25 percentage points since the previous survey in 2018.
Feasibility and operability are another matter. Asset managers are striving to meet client demands, but with the risk of accusations for greenwashing if a mistake is made. A lack of rigour or even a good-faith error could lead to a substantial reputational hit.
Managing potential reputational risk
Fortunately for the industry, the CSSF appears to recognise the difficultly of the task. ‘It can never be assured that all market participants and respective competent authorities in the EU will have the same interpretation of the regulation, and apply the same set of criteria,’ said Paul Wilwertz, head of communication with the CSSF.
Deciding whether funds have sustainable characteristics (so called ‘article 8’ funds) or have explicitly sustainable investment strategies (‘article 9’ or impact funds) is a particular challenge, with the potential for playing one regulator off against another. Mr Wilwertz is relatively relaxed about this latter point: ‘We do not anticipate much discrepancy in the way different jurisdictions would categorise similar funds or the same fund.’ The Joint Committee of the three European Supervisory Authorities published draft regulatory standards on 4 February, but inevitably details and ideas of how these rules will be interpreted is lacking.
Playing it safer
Given the uncertainty, the temptation is to play it relatively safe for now, and allocate funds either to the non-impact, sustainable category (article 8) or rank funds as clearly non-sustainable (article 6). Anecdotal evidence suggests this approach has been taken by many asset managers, including the ING group. ‘Concerning our internal products like ING Aria Lion fund range, our management company has categorised the products as sustainable (article 8) or non-sustainable (article 6),’ Simeoni said. ‘We are in a transition phase and we should convert the vast majority of our range to article 8 before mid-2022,’ he said, adding ‘we are not in hurry to convert at any price, and want to preserve our long-term track record and the total expense ratio of our funds.’
Best efforts from regulators
Regulators are expected to take a best-efforts approach. Even though the CSSF has implemented a fast-track procedure for the approval of amended prospectuses, asset managers should not assume this is an invitation to cut corners. ‘Spot checks and requests for clarification where relevant are in place with the aim that only revised prospectus deemed to contain fair and coherent information for the investors will be released,’ said Wilwertz.
‘Once the entire regulation is entirely in force, the new regulatory obligations will become an integral part of the ordinary ongoing supervisory framework of the funds,’ he added. The CSSF, like the industry, is about to set out on a journey of discovery.