knowledge 16 November 2022 |

Asset Management: Developments in Sustainability Disclosures

The Note is intended to provide information on the main disclosure issues and outline risks identified by the CBI in terms of potential greenwashing or areas where there has been a lack of transparency or clarity. The key aspects of the Note relate to (a) the CBI’s findings from its ‘Gatekeeper Review’ of investment fund disclosures, and (b) the CBI’s supervisory roadmap in respect of sustainability disclosures.

1. Findings of the ‘Gatekeeper Review’ of Investment Fund Disclosures

The CBI states that it undertook a ‘Gatekeeper Review’ to ascertain whether the disclosures in fund documentation provide investors with clear information to assess the sustainability characteristics of a fund, as well as to ascertain what sustainability risks may exist in a particular fund.¹ The CBI reviewed a sample of submissions received through the CBI’s 2021 streamlined filing processes. The CBI states that the extent of compliance with SFDR Level 1 and Taxonomy Regulation disclosures varied significantly across the sample reviewed. The principal issues identified and CBI expectations in respect of same are highlighted below:

• SFDR Classification
  
  The CBI states that fund documentation should clearly disclose the relevant SFDR classification (ie, Article 6, 8 or 9 of SFDR) without giving the impression of a ‘label’ to investors. The CBI expects that where an existing fund proposes a change in its SFDR classification, the post-authorisation submission should include a detailed rationale and justification for the proposed change. In addition, adequate consideration should be given to the effect of a change in classification for existing investors in the fund and ensuring appropriate communication with those investors. The CBI expects fund managers (i.e., UCITS management companies and AIFMs) to keep classifications under regular review and, although changes to SFDR classifications may take place, fund managers should be able to stand over the classification applied to their funds. The CBI states that, on this basis, the CBI would not expect numerous changes to a fund’s SFDR classification.

• Generic sustainability risk and/or taxonomy-alignment disclosures
  
  The CBI observes that some of the funds assessed only included generic sustainability risk and/or taxonomy-alignment disclosure. The CBI expects that disclosures should be specific to the fund in question and fund managers should keep those disclosures under regular review to ensure their accuracy.

• Quantification of taxonomy-alignment
  
  The CBI notes that only a small number of funds provided a percentage proportion of investments in environmentally sustainable economic activities and in those cases, detailed information on the economic activities that qualify as environmentally sustainable was provided. The CBI states that disclosures around the quantification of taxonomy-alignment must improve and fund managers should keep such disclosures under regular review to ensure their accuracy.

• Integration of sustainability risks
  
  Subject to some exceptions, the CBI observes that generally funds provided a detailed outline of the reasons why sustainability risks were not relevant thereby fully addressing requirements. The CBI reminds fund managers that disclosures must be specific to the fund in question and kept under regular review to ensure their accuracy.

• Pre-contractual product disclosures – benchmark indices
  
  The CBI states that a number of the funds’ disclosures lacked the expected detail in terms of how the designated index was consistent with the environmental and/or social characteristics the fund promotes. In addition, the CBI has concerns about responsibility for monitoring the composition of the benchmark index against screening criteria. In some cases, the CBI notes that it appeared that the UCITS management companies/AIFMs did not intend to carry out monitoring of an investment manager’s ESG approach on an ongoing basis, but intended to rely on an annual assessment of the application of the ESG strategy. The CBI states that such practices are not considered appropriate and the fund manager should have processes in place to monitor on an ongoing basis the relevant index provider or delegate investment manager.

• Naming convention for funds
  
  The CBI observes that naming conventions in the funds assessed were consistent with the fund disclosure outlined in the investment objective and strategy of the relevant fund. The CBI highlights that terms such as ‘ESG’, ‘green’, ‘sustainable’, ‘social’, ‘ethical’, ‘impact’ or any other ESG-related terms should be used only when supported in a material way by evidence of sustainability characteristics, themes or objectives that are reflected fairly and consistently in the fund’s investment objective and policy and its strategy. The CBI also confirms that the use of any impact-related term should be used only by funds whose investments are made with the intention to generate positive, measurable social and environmental impact alongside a financial return. The CBI highlights that fund managers should ensure that fund names are not misleading.

2. Supervisory Roadmap

In the Note, the CBI outlines a non-exhaustive list of areas of focus which may form part of a supervisory roadmap in the future. We have summarised these areas of focus in the box below:

 

Supervisory Roadmap
Adaption of Risk Management Frameworks	The CBI notes that fund managers are required to integrate sustainability risks and sustainability factors in their operations (further detail on these requirements are outlined in our briefing (here)). The CBI also reminds fund managers of the content of its ‘Dear CEO’ letter in relation to ESG expectations (further detailed in our briefing (here)).
Article 8 ‘Guardrails’	The CBI notes that the definition of an Article 8 compliant product under the SFDR does not contain minimum investment thresholds or any prescribed composition of investments. The CBI states that supervisory engagement will focus on funds with a low proportion of their portfolio promoting environmental and/or social characteristics. The CBI confirms that it may also examine funds which have changed their SFDR classification and consider further the rationale provided at the time of the change.
Marketing Material	Where necessary, the CBI will assess the consistency of sustainability-related disclosures across fund documentation (such as the prospectus and the fund rules/articles of association) and marketing material.
Fees & Costs	The CBI states that fees and costs associated with ‘green’ investment products should be transparent and proportionate and investors should not be subject to undue costs.
Securities Lending	The CBI states that it is interested in funds that engage in securities lending whilst also promoting environmental and/or social characteristics and/or having sustainable investments as their objective. The CBI highlights a particular interest as being whether those funds are in a position to meet their environmental and/or social characteristics if they have lent out shares and those shares take contradictory positions.
Fund Service Providers	In assessing SFDR compliance, the CBI will also consider the role played by certain fund service providers, including depositaries. The CBI states that it may consider: whether depositaries include ESG-related investment restrictions in the monitoring of the instructions from the fund manager (or the delegated investment manager); and how a depositary would categorise a breach of an ESG-related investment restriction and the circumstances in which they would report such breaches to the CBI or in financial statements.

Other Developments

At a European level, there are further amendments to the SFDR regulatory technical standards (the “SFDR RTS”) on the horizon. The European Commission had mandated the European Supervisory Authorities (the “ESAs”) to review principal adverse impact (“PAI”) indicators and financial product disclosures and produce amended draft SFDR RTS by April 2023 (here). On 14 November 2022, the ESAs published notification of a six month delay to this review (here). For convenience, we have set out in the box below a quick reference guide to the timeline for SFDR RTS revisions:

 

Timeline of SFDR RTS Revisions
First Iteration: SFDR RTS laid down in Commission Delegated Regulation (EU) 2022/1288 of 6 April 2022 (here)	Applies from 1 January 2023.
Second iteration: SFDR RTS adopted by the European Commission on 31 October 2022 to provide for gas and nuclear disclosures and introduce some further minor amendments (here).	Adopted by European Commission, currently subject to European Parliament and Council of the EU scrutiny. If neither object, this Delegated Regulation containing amended SFDR RTS will be published in the Official Journal and enter into force three days after being published.
Third iteration: SFDR RTS relating to the ESA’s review of PAI indicators and financial product disclosures.	On 14 November 2022, the ESAs published a notification to the European Commission that the deadline of 28 April 2023 for delivery of amended SFDR RTS will be delayed by up to 6 months.

 

Comment and next steps

Fund managers will be working towards the 1 December 2022 deadline for streamlined filing of SFDR RTS disclosures with the CBI; this filing process is outlined in further detail in our briefing (here). The expectation is that these filings will be based on the existing SFDR RTS and will not reflect the updated disclosure requirements in the amended SFDR RTS currently subject to European Parliament and Council of the EU scrutiny on the basis that the amended SFDR RTS are unlikely to come into force before 1 January 2023.

The Deputy Governor of the CBI states that this deadline provides an ‘opportunity for fund managers to make any necessary pre-contractual updates and ensure any areas of weakness are addressed’ and confirms that the CBI’s ‘tolerance for any disclosures that do not meet the requirements will be low considering the length of time industry has now had to comply with these key regulatory changes’.² Fund managers should take note that the CBI states that a sample of submissions received will be reviewed retrospectively to ensure a high standard of disclosure.

The headline message from the CBI in recent communications is the expectation that from January 2023, any information provided to investors must be fully aligned with the requirements of SFDR, the Taxonomy Regulation and related available guidance. Notwithstanding this CBI expectation, it should be noted that regulatory requirements in this area continue to evolve. In addition to the expected amendments to the SFDR RTS outlined above, the ESAs continue to raise queries of interpretation in respect of sustainability requirements; most recently, the ESAs sent a list of additional queries relating to the interpretation of the SFDR which are outlined in further detail in our briefing (here).  Assessing and ensuring compliance with evolving sustainability requirements will continue to pose a challenge for market participants.