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In July 2023, the European Securities and Markets Authority ("ESMA") launched a common supervisory action ("CSA") with national competent authorities ("NCAs") on the integration of sustainability...
In July 2023, the European Securities and Markets Authority
("ESMA") launched a common supervisory
action ("CSA") with national competent
authorities ("NCAs") on the integration
of sustainability risks and disclosures in the investment fund
sector. ESMA's aim in conducting the CSA was to assess and
foster compliance of supervised entities with:
the amendments to the directive on Undertakings in Collective
Investment in Transferable Securities ("UCITS
Directive") and the Alternative Investment Fund
Managers Directive ("AIFMD") introducing
measures on the integration of sustainability risks;
the current regulatory framework under the Sustainable Finance
Disclosure Regulation ("SFDR") including
the financial product disclosure of the share of investments
aligned with the criteria set out in the Taxonomy Regulation
and
the adherence to the principles of the ESMAsupervisory briefing on sustainability risks
and disclosures in the area of investment management, published in
May 2022.
ESMA has now published its final report setting out its findings.
Overall, ESMA has concluded that there is room for improvement in
the level of fund managers' compliance with the framework.
Despite the finding by the majority of NCAs that the overall level
of compliance was satisfactory, several vulnerabilities were
identified which were addressed as part of the review through
bilateral letters and other supervisory orders. In addition to
highlighting cases of non-compliance, good practices and below
average practices, the report sets out ESMA's specific
recommendations to NCAs and market participants.
Key Findings
The table below provides an overview of the main issues and
vulnerabilities identified by NCAs during the review.
Disclosures
Vague and overly general language, missing or inadequate
details, difficult to locate disclosures and use of jargon.
Inconsistencies between pre-contractual, periodic and website
disclosures and marketing material.
Environmental or social characteristics in the pre-contractual
information were not clearly disclosed, making it unclear how the
characteristics were measured and fulfilled.
Consideration of Principal Adverse
Impacts (PAI)
PAI Statements at Entity Level: inadequate
level of details and unsatisfactory explanation of
non-consideration, inconsistencies in the calculations
DNSH assessment for "sustainable
investments": all mandatory PAI indicators listed in
Table 1 of Annex I to the SFDR Level 2 Regulation must be taken
into account when carrying out the do no significant harm (DNSH)
assessment to determine whether or not an investment is a
"sustainable investment" within the meaning of the SFDR.
Indicators from Table 1 of Annex I cannot be left out on the basis
of insufficient or unreliable data
Integration of Sustainability
Risks
Lack of properly documented policies ensuring alignment of the
relevant sustainability risks in the investment decision with the
funds' investment strategies.
Lack of escalation procedures in case of breach of
policies.
Lack of due diligence on how sustainability risks are
integrated in the investment management process.
Lack of description of sustainability indicators and the
corresponding limits in the fund risk profile.
Inadequacies in the frequency of reporting to senior management
of board of directors.
Room for improvement in how sustainability risks are taken into
account for different types of assets such as cash, fixed-term
deposits, structured products and derivative instruments.
Article 6 funds must be considered in risk management
processes.
Sustainability risks and greenwashing risks are not to be
treated as the same type of risk. Clear definitions of greenwashing
risk within policies is important, along with robust procedures for
identifying and managing conflicts related to greenwashing.
Resources
Cases of low number of dedicated employees for sustainability
tasks, or unsatisfactory knowledge of sustainability matters from
the relevant employees.
Training to enhance sustainability related skills should be
delivered at a regular frequency and evidenced.
Remuneration Policies
Lack of specific criteria and indicators to measure how
remuneration policies are consistent with the integration of
sustainability risk.
Controls and Processes in Place
Lack of processes to ensure that the description of the
funds' ESG strategies is substantiated by the ESG metrics /
data used or is consistent with environmental and / or social
characteristics and good governance principles.
Internal control systems have been identified as an area of
focus for ongoing supervision. In some cases, supervised entities
did not integrate sustainability risks in the third level of
control. The 2025 CSA on compliance and internal audit functions
will provide NCAs with an opportunity to investigate this area
further.
ESG Data
Lack of verification or review process of data from third
parties.
Data sometimes incomplete or inaccurate.
Auditing System
Lack of audit of the implementation of internal policies
Many NCAs have already issued bilateral letters to entities to
ensure compliance and outline specific areas for improvement and
have highlighted to ESMA that they have followed up or will follow
up on the CSA's main findings (in particular those related to
incorrect use of names, use of suggestive non-textual imagery and
incomplete or missing disclosures). While ESMA acknowledges
NCAs' general preference to use escalated supervisory measures
instead of taking enforcement measures, it reiterates the
importance of using the "full range of the supervisory and
enforcement toolkit" available to NCAs. ESMA also notes that
the ongoing review of SFDR Level 1 will not lead to changes in the
near future and therefore NCAs should remain vigilant on the
supervision of the current framework.
The Central Bank of Ireland has indicated that it will issue its
own communication following the conclusion of the CSA and the
publication of ESMA's report.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
