As the dust settles on the adoption of the SFDR1 and fund managers and their legal teams look ahead to the adoption of the more prescriptive Level 2 Regulations2 and the Taxonomy Regulation3 , we have reviewed the prospectuses and website disclosures of a selection of the top 20 fund managers with Irish UCITS and identified some early trends in the new sustainability disclosures on the market.
What Are The Disclosure Requirements?
The primary aim of the SFDR is to ensure that investors are equipped to make a reasoned decision in a transparent market with the hope that capital flows will ultimately be rerouted to sustainable investments. The first raft of disclosures set out in the SFDR require fund managers to disclose the following information to investors: (i) the manner in which sustainability risks are integrated into investment decisions; and (ii) the results of the assessment of the likely impacts of sustainability risks on the returns of an investment fund.
There are further disclosures required for so-called Article 8 or "light green funds" and Article 9 or "dark green funds". A minority of managers have opted to disclose on their websites how each of their products are classified, which is useful as a quick resource for investors. Most managers tend to make these disclosures in individual offering documents or on a dedicated product webpage.
How Have Managers Approached The Disclosure Requirements?
Most managers have taken a high-level principle-based approach, seeking to ensure compliance with the general principles set out in the SFDR. These disclosures are generally incorporated into the offering documentation by way of a full prospectus and supplement update, but some managers have opted to issue an addendum to the prospectus. Generally, managers have not yet included the more prescriptive disclosures required by the Level 2 Regulations.
Similarly, by and large, managers have not yet included disclosure on how principal adverse impacts are considered at fund level as required by Article 7. This is unsurprising given that managers have until 30 December 2022 to comply with this disclosure requirement. Some managers have included disclosures noting that work on compliance with Article 7 is in progress and will be completed following the finalisation of the Level 2 Regulations. Where managers have considered this at a fund level, the current disclosures tend to be quite broad and refer prospective investors back to the policies developed at manager level.
Managers have tackled the Article 4 requirements for entity-level consideration of principal adverse impacts and integration techniques by way of updating their websites with these disclosures or by issuing specific policies. The level of detail contained in these Article 4 disclosures varies considerably across managers.
Trends Which Have Emerged
Prospectus and Supplement Disclosures
For the most part, a common approach to disclosures has emerged. In the case of umbrella fund structures, general disclosures seeking to comply with Article 6 are generally set out in the main body of the prospectus and apply to each sub-fund, with the Article 8 and Article 9 specific disclosures being set out in specific fund supplements.
Managers have tended to include the following in their prospectus and supplement disclosures:
- a description of what sustainable investing means to that manager with most managers adhering to a broadly similar definition in line with Article 2;
- references to adoption of a sustainable investing policy, with managers referring potential investors to their websites for further information;
- a non-exhaustive list of sustainability risks, which highlights that such risks may have an adverse effect on the value of the fund, with most managers broadly referring to the same types of risks;
- in terms of integration of sustainability risks into the portfolio management process, managers have generally disclosed integration techniques such as the use of external and internal sustainability research, active engagement with issuers, exercise of voting rights, use of exclusion screening, use of proprietary and third-party ESG rating scores, investment stewardship and impact investing;
- many managers have created in-house ESG rating processes to assess the performance of issuers; and
- in relation to index funds, managers have generally disclosed that although asset allocation is dictated by the relevant index, the manager will actively engage with issuers constituting the index to assess and influence sustainable investing initiatives.
Many prospectuses refer investors back to the manager's website to consider the manager level policies and their own past performance in the ESG sphere, with some offering specific examples of how their investing has made a positive contribution to a number of environmental and social initiatives, such as engaging with charitable foundations to include sustainability criteria in the management of their endowments; investing in more diverse female-led companies; and investing in clean, green technology which taps into the growing transition to renewable energy in line with the move from a linear to a circular economy.
Article 8 versus Article 9 Funds
Perhaps unsurprisingly, most existing funds fall outside of the scope of the Article 8 or Article 9 requirements. However, 63% of funds launched and repositioned in Europe last year were in scope and this is expected to rise to 70% in 20214 , which is undoubtedly a response to a perceived demand for products of this nature. The split between Article 8 and Article 9 funds varies from manager to manager, with most managers having an offering of at least one Article 8 fund but fewer having any Article 9 fund offering. As is to be expected however this is changing rapidly, with many managers currently working on the addition of an Article 9 fund to their offering. It remains to be seen which classification will prove to be the more popular product with investors, which will, in turn, inform the offering from managers.
Some 'light green' Article 8 fund disclosures have extensive detail of the ESG characteristics promoted, the screening process for investments, and the sustainability indicators used, whilst others simply refer to the investment considerations without any substantive analysis. The 'dark green' Article 9 fund disclosures tend to include a detailed climate change-focused investment analysis and exclusion policies, in line with the disclosure requirements.
Trends in Focus
Interestingly, some managers have also included more specifics on integration techniques. Some managers have listed specific engagement triggers for example, where an investee company has an underrepresentation of women on its board. Disclosures also include the importance of long-term value creation by analysing investee companies' long-term strategy in terms of risk, executive remuneration, executive succession planning, diversity, and health and safety issues. Most managers have adopted detailed integration policies which focus on a bottom-up approach and highlight the need for rigorous analysis and constant review of same.
Some managers have emphasised the importance of climate change risk by applying a separate climate score to each investment in addition to other ESG scores and others have made specific reference to their climate change policy at the manager level.
Disclosures also note that integration of sustainability risk is only one facet of investment analysis, and that the use of ESG screening may result in funds forgoing opportunities both on the buy-side and sell-side, which may have a negative impact on fund performance and that disclosed ESG analysis may be changed without shareholder approval. Many disclosures describe sustainability risks as both a stand-alone risk and a cross-cutting risk manifesting itself through numerous financial and business risks.
Looking to the Future
Managers have also noted the impact of COVID-19 on ESG considerations with many highlighting how their policy of active engagement came to the forefront as companies' business continuity plans were put to the test in 2020 in a most sudden and unexpected way. This crisis also highlighted how ESG investing may indeed be the most sure-fire way to ensure medium/long-term growth is maximised going forward. This is a rapidly changing landscape and we would predict most of the selected managers to have an Article 9 UCITS fund on offer in the coming months.
Footnotes
>1. Regulation (EU) 2019/2088 of The European Parliament And of The Council of 27 November 2019 on Sustainability-Related Disclosures In The Financial Services Sector.
2. the draft regulatory technical standards with regard to the content, methodologies and presentation of disclosures pursuant to Article 2a (3), Article 4(6) and (7), Article 8(3), Article 9(5), Article 10(2) and Article 11(4) of Regulation (EU) 2019/2088 contained in the final report from the European Supervisory Authorities to the European Commission dated 2 February 2021.
3. Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088.
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