Asset Management: Developments in Sustainability Disclosures

On 14 November 2022, the Central Bank of Ireland (the ‘CBI’) published an information note ‘Sustainable finance and the asset management sector: Disclosures, investment processes & risk management’ (the ‘Note’).

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. 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. A summary of areas of focus is set out below:

  • Adaption of Risk Management Frameworks

The CBI notes that fund managers are required to integrate sustainability risks and sustainability factors in their operations. The CBI also reminds fund managers of the content of its ‘Dear CEO’ letter in relation to ESG expectations.

  • 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 – (i) whether depositaries include ESG-related investment restrictions in the monitoring of the instructions from the fund manager (or the delegated investment manager); and (ii) 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. On 14 November 2022, the ESAs published notification of a six month delay to this review. For convenience, please see 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. 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.

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.

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