knowledge 30 June 2022 |

Fund Management and Sustainability Developments

1 August 2022 - Integration of Sustainability Risks and Sustainability Factors

In April 2021, two delegated acts were adopted by the European Commission which will require FMCs to take account of sustainability risks and sustainability factors in their operations. Delegated Directive (EU) 2021/1270¹ imposes requirements on UCITS management companies and Delegated Regulation (EU) 2021/1255 imposes requirements on alternative investment fund managers (“AIFMs”).

‘Sustainability risks’ and ‘sustainability factors’ are defined by reference to the Sustainable Finance Disclosure Regulation (“SFDR”)²:

• ‘Sustainability risk’ means an environmental, social or governance event or condition that, if it occurs, could cause an actual or a potential material negative impact on the value of the investment; and

• ‘Sustainability factors’ means environmental, social and employee matters, respect for human rights, anti‐corruption and anti‐bribery matters.

Key provisions of these delegated acts include:

1. Organisational Requirements
   
   FMCs must take into account sustainability risks when complying with general requirements on procedures and organisation, ie, decision-making procedures, organisational structure and internal control mechanisms.

2. Resources
   
   FMCs must retain the necessary resources and expertise for the effective integration of sustainability risks.

3. Senior Management Responsibility
   
   FMCs must ensure that senior management is responsible for the integration of sustainability risks in activities such as implementation of investment policy, approval of investment strategies, investment decision procedures and risk management policy.

4. Conflicts of Interest
   
   When FMCs identify the types of conflicts of interest which may damage the interests of a fund, those FMCs must include conflicts of interest that may arise as a result of the integration of sustainability risks in their processes, systems and internal controls.

5. Due Diligence
   
   Where FMCs consider principal adverse impacts of investment decisions on sustainability factors as described in Article 4(1), point (a), of SFDR, or as required by paragraphs 3 or 4 of Article 4 of SFDR, those FMCs must take into account those principal adverse impacts when complying with due diligence requirements. FMCs should also take account of sustainability risks when complying with due diligence requirements.

6. Risk Management Policy
   
   FMCs must ensure that risk management policy comprises such procedures as are necessary to enable the FMC to assess exposure of a fund to sustainability risks.

Comment

Compliance with the 1 August 2022 deadline may present challenges for those FMCs who manage non-ESG funds (Article 6 Funds) or who utilise a delegation model, however all FMCs should make preparations to review and update their policies, procedures and systems. This preparatory work may involve obtaining information from delegates and/or underlying funds and FMCs should begin this process as soon as possible.

CBI Approach to Taxonomy Disclosures

FMCs should also take note of the recently issued ‘Central Bank Approach to Taxonomy Disclosures in the period until 1 January 2023’. This CBI communication follows a number of European Supervisory Authority clarifications which we detailed in our earlier briefing here.  The CBI now confirms that:

• where an FMC decides to take into account the EU criteria for environmentally sustainable economic activities, in order to comply with Article 5(b) of the Taxonomy Regulation the CBI expects pre-contractual disclosure (explicit quantification), based on reliable data, of the minimum proportion of investments in economic activities that qualify as environmentally sustainable under Article 3 of the Taxonomy Regulation. The CBI confirms that the numerical disclosure may be accompanied by a qualitative clarification explaining how the FMC addresses the determination of the proportion of taxonomy-aligned investments of the fund, for example, by including the sources of information for the determination. The CBI confirms that an FMC may reference making complementary assessments and estimates on the basis of information from other sources in exceptional cases and only for those economic activities for which complete, reliable and timely information could not be obtained, however these exceptional cases must mirror those detailed in the Commission’s Q&A (here)³;

• where an FMC decides not to take into account the EU criteria for environmentally sustainable economic activities⁴, in order to comply with Article 5(b) of the Taxonomy Regulation the pre-contractual document disclosure must indicate zero investments in economic activities that qualify as environmentally sustainable under Article 3 of the Taxonomy Regulation; and

• in the above cases, the CBI expects that disclosures should not include negative justifications nor leave ambiguity about the alignment of the investments of the fund with the Taxonomy Regulation. The CBI also confirms that pre-contractual disclosure should not refer to ‘incidental investment’.

The CBI confirms that disclosure updates or amendments should be carried out at the earliest available opportunity, or updated over the normal course of business, or at the very latest, 1 January 2023.

Comment

FMCs should take note of the CBI’s approach to taxonomy disclosures with a view to complying with same. FMCs should also keep in mind that the CBI has indicated that a thematic review on sustainable finance will take place in Q3 2022.