In recent years, environmental, social and governance (ESG) factors have become a key discussion point in the asset management industry, with many managers now incorporating ESG considerations into their investment processes. It is a topic that continues to gain global importance. In the EU, the impetus stems primarily from the EU Sustainable Finance Action Plan and remains on the top of the regulatory agenda. There have been some key developments taking the form of new legislation and amendments – proposed and actual – to existing legislation.

Of most significance are the Sustainable Finance Disclosure Regulation¹ (SFDR) and the Taxonomy Regulation² that impact “Financial Market Participants” (FMPs) (which includes, amongst others, AIFMs, UCITS ManCos, Portfolio Managers/Advisors) in relation to “Financial Products” (which includes, amongst others, AIFs, UCITS and segregated investment management mandates).

The SFDR, which took effect on 10 March 2021, impacts both firms and products and requires three types of disclosure – website disclosure, pre-contractual disclosure and periodic reporting. It requires FMPs to make significant changes to their pre-March 2021 processes.

There were, and remain, challenges to meeting the requirements of the SFDR. The SFDR included provisions requiring the European Supervisory Authorities (ESAs) to prepare level 2 regulatory technical standards (RTS) to provide further detail and to assist in the application of the SFDR provisions before 30 December 2020. However, in October 2020, the EU Commission announced that the RTS would not apply on 10 March 2021 but would apply at a “later stage.” On 4 February 2021, the ESAs published a final report on the RTS, which proposed changes to the original draft RTS that were published in April 2020 (the Revised RTS). On 25 February 2021, the ESAs issued a Supervisory Statement on the application of the SFDR, which confirmed the delay of the application of the SFDR RTS and proposed an application date of 1 January 2022, which is the date on which the Taxonomy Regulation takes effect.³ The ESAs’ letter also included a summary table setting out the effective dates of the SFDR and Taxonomy Regulation disclosure obligations and recommended that national competent authorities encourage FMPs to use the period from 10 March 2021 until 1 January 2022 to prepare for the application of the RTS.

However, in a subsequent letter⁴ dated 8 July 2021, the EU Commission’s Director-General for Financial Stability, Financial Services and Capital Markets Union confirmed that the date of application of the RTS would be further delayed – proposing deferral by six months. Rather than applying on 1 January 2022, the RTS will now apply from 1 July 2022. (See our OnPoint on the delay, “RTS under the SFDR – a six- month reprieve” available. The letter also stated that the ESAs are currently preparing an additional six draft RTS based on Articles 8(4), 9(6) and 11(5) of the SFDR – the deadline for submission (1 June 2021) has already passed. The EU Commission plans to bundle all 13 of the regulatory technical standards into a single delegated act, and it is expected that these will be published in the Autumn of 2021. These as yet unpublished draft RTS are likely to further amend the draft RTS dated 4 February 2021 (as amended by the draft RTS dated 15 March 2021, regarding which see further below).

On 7 January 2021, the ESAs wrote to the EU Commission highlighting that they had encountered several important areas of uncertainty in the interpretation of the SFDR and asked for clarification on a number of points. On 26 July 2021, the EU Commission published its long-awaited Q&A,⁵ which attempts to respond to the ESAs’ specific questions. Unfortunately, rather than providing the desired clarity, in many areas, the EU Commission merely repeats the ESAs’ questions or cites sections of SFDR level 1 text, without adding substantive detail on important matters pertaining to the interpretation of the SFDR. See our OnPoint “EU Commission Publishes Q&A on the application of SFDR”.

The SFDR went ‘live’ on 10 March 2021, but there have been further ESG-related developments in addition to those mentioned above relating to the delay of the Revised RTS. On 15 March 2021, the ESAs issued a consultation paper that proposed further amendments to the Revised RTS that were published in February 2021. The amendments to the Revised RTS set out in the consultation paper address the level 2 disclosures that the ESAs are mandated to draft pursuant to the provisions of the Taxonomy Regulation. These Taxonomy-related RTS deal with additional disclosures for Article 8 and Article 9 financial products making use of the environmental taxonomy. The rationale for amending the Revised RTS instead of creating a new rule set, was to minimise duplication and complexity in this area. For a comprehensive overview of the challenges associated with the implementation of the SFDR and Taxonomy Regulation related developments, please see our OnPoint “The SFDR Jigsaw – putting the pieces together”.

Additional regulatory developments in the ESG space include the EU Commission announcing, on 21 April 2021, that they had adopted delegated acts that propose amendments to MiFID II (product governance/organisational requirements), to the UCITS Directive and to AIFMD. The delegated acts were published in the Official Journal of the EU (OJ) on 2 August 2021 and entered into force on 22 August 2021 (that is, 20 days after publication in the OJ). In terms of application of the amendments, the delegated acts relating to AIFMD⁶ and UCITS⁷ apply from 1 August 2022, the delegated act relating to MiFID II organisational requirements⁸ applies from 2 August 2022 and the delegated act relating to MiFID II product governance requirements⁹ applies from 22 November 2022. In addition, following consultations on changes to the Non-financial Reporting Directive (NFRD), on 21 April 2021, the EU Commission announced proposals for a new Corporate Sustainability Reporting Directive (CSRD), which would amend reporting requirements contained in NFRD. CSRD aims to ensure consistency between reporting requirements contained in the Taxonomy Regulation and company sustainability reporting.

Additional rules and regulations relating to sustainable development take the form of the EU Ecolabel framework for certain financial products and Green Bond Standards, proposals for a European Climate Law that aims to write the EU’s climate neutrality target into binding legislation, together with local developments such as the AMF’s ESG-related Doctrine.¹⁰ The EU also enacted the Low Carbon Benchmark Regulation, which entered into force in December 2019. The Low Carbon Benchmark Regulation amended the EU Benchmarks Regulation by introducing two new types of “climate benchmark,” which seek to ensure the integrity of low-carbon benchmarks.

There have also been developments in relation to ESG in Germany. On 2 August 2021, the German Financial Supervisory Authority (BaFin) published a consultation paper seeking views on its draft guidelines for sustainable funds (Guidelines). The Guidelines set out certain investment conditions pertaining to sustainability that are required for ‘sustainable’ German retail funds to prevent “greenwashing.” The BaFin has stated that the requirements of the SFDR and the Taxonomy Regulation will not be impacted by the proposals set out in the Guidelines. The Guidelines would not be applicable to non-German funds that are registered for distribution in Germany. The consultation closed on 6 September 2021.

The UK’s post-BREXIT ESG agenda

Neither the SFDR nor the Taxonomy Regulation were ‘on-shored’ in the UK as a piece of existing EU legislation following the end of the Brexit transition period (which was 11.00 p.m. on 31 December 2020), and it is now clear that the UK’s position will diverge from the EU’s. Notwithstanding the divergence, the UK government has stated that “at the very least, we will match the ambition of the EU Sustainable Finance Action Plan.”

The UK’s legislative proposals in the field of sustainable finance are focussed on the recommendations of the Task Force for Climate-related Financial Disclosures (TCFD) – aimed at ensuring climate-related risks and opportunities are priced into financial decision-making. The UK was one of the first countries worldwide to endorse the TCFD recommendations, and the UK’s 2019 Green Finance Strategy outlined an expectation that all UK listed issuers and large asset owners would be making disclosures in accordance with the TCFD’s recommendations by 2022.

The UK continues to develop its own post-Brexit regulatory and legislative agenda with the Financial Conduct Authority (FCA) and HM Treasury launching a number of initiatives. On 9 November 2020, HM Treasury published an Interim Report of the UK’s Joint Government-Regulator TCFD Taskforce (the Report) and a Roadmap (the Roadmap) that provide an outline of the UK’s ambitions on climate change mitigation. The UK Taskforce describes itself as “charting a path towards mandatory TCFD-aligned climate-related disclosures to help accelerate progress.” The Roadmap sets out an indicative path for the introduction of regulatory rules and legislative requirements over the next five years. The Report also sets out the implementation approach for Asset Managers. (See our OnPoint “Is Brexit Green? A UK Roadmap Towards Mandatory Post-Brexit Climate-Related Disclosures”. In addition, on 19 April 2021, the FCA announced the appointment of a new sustainability director. This is a new role that will see the director develop the FCA’s approach to sustainable finance domestically and internationally. The role is part of the measures introduced to fulfil the government’s commitment to achieve a net-zero economy by 2050.

On 24 March 2021, the UK’s Department of Business, Energy and Industrial Strategy published a consultation paper seeking views on proposals to mandate climate-related financial disclosures by publicly quoted companies, large private companies and LLPs in relation to financial periods beginning on or after 6 April 2022. The stated objective of these disclosures is “to increase the quantity and quality of climate-related financial disclosures in a proportionate manner. This is both to ensure market participants have better information to adequately understand climate-related financial risks and opportunities to support the transition to net zero, but also to help companies think about what they need to do to address climate change as an important risk and opportunity for their organisation, operations and people.”¹¹ The consultation closed on 5 May 2021.

Linked to the delivery of the proposals set out in the Roadmap, in June 2021, the FCA published two consultation papers for new proposals on climate-related disclosure rules for listed companies and new proposals for asset managers, life insurers and FCA-regulated pension providers¹² (CP1/18 and CP 21/17 respectively). The new proposals are among the FCA’s first substantive policy proposals for the UK asset management and asset owner sectors since the end of the EU Withdrawal transition period. Given the global reach of regulated firms operating in the UK, the FCA has stated that it has approached the design of the regime “with international consistency in mind and to accommodate firms’ different business models.” The consultations closed on 10 September 2021 and, subject to the feedback it receives, the FCA plans to publish a statement to confirm its final policy on climate-related disclosures before the end of 2021. Subject to the response to the consultation papers, new rules applicable to UK asset managers will come into force in January 2022, with new firm and product level disclosures to be made from June 2023. For more information, please see our OnPoint “FCA Consultation on Enhancing Climate-Related Disclosures by UK Asset Managers”.

In addition, on 19 July 2021 the FCA published a ‘Dear Chair’ letter¹³ addressed to the chairs of authorised fund managers (AFMs) containing guiding principles on design, delivery and disclosure of ESG and sustainable investment funds. The letter also sets out examples of where the FCA has seen applications for authorisation of investment funds with an ESG/sustainability focus that have fallen below the FCA’s expectations. In the annex to the letter, the FCA sets out ‘guiding principles’ that are relevant where an FCA authorised investment fund pursues a responsible or sustainable investment strategy and claims to pursue ESG/sustainability characteristics, themes or outcomes. These principles are targeted at funds that make specific ESG-related claims, and do not apply to funds that integrate ESG considerations into mainstream investment processes. The guiding principles comprise an overarching principle and three supporting principles, with each principle being accompanied by a set of key considerations. The guiding principles are intended to complement proposals set out in CP 21/17. While the UK’s proposals currently focus on sustainable finance and the “E” of ESG, in July 2021 the FCA published a consultation paper that proposes changes to the current FCA Listing Rules to require companies to disclose annually on a comply or explain basis whether they meet specific board diversity targets and to publish diversity data on their boards and executive management. For more information, please see our OnPoint “Diversity and Inclusion in the UK Financial Sector – The UK Regulators' Proposals”. It remains to be seen what measures, if any, the UK legislature and regulators will take with regards to the development of policies and legislation in the areas of “S” and “G”.

Footnotes

1. Regulation (EU) 2019/2088.
2. Regulation (EU) 2020/852.
3. The ESAs’ Supervisory Statement.
4. The 8 July 2021 letter regarding the delay in application of the RTS is available.
5. To access the EC’s Q&A.
6. Commission Delegated Regulation (EU) 2021/1255 amending Delegated Regulation (EU) 231/2013 as regards the sustainability risks and sustainability factors to be taken into account by alternative investment fund managers.
7. Commission Delegated Directive (EU) 2021/1270 amending Directive 2010/43/EU as regards the sustainability risks and sustainability factors to be taken into account for UCITS.
8. Commission Delegated Regulation (EU) 2021/1253 amending Delegated Regulation (EU) 2017/565 as regards the integration of sustainability factors, risks and preferences into certain MiFID II organisational requirements and operating conditions for investment firms.
9. Commission Delegated Directive EU 2021/1269 amending Delegated Directive (EU) 2017/593 as regards the integration of sustainability factors into the MiFID II product governance obligations is available.
10. For our latest update on the AMF Doctrine, please see our OnPoint “AMF ESG Doctrine: Goldplating SFDR by another name?”.
11. Page 8 of the Consultation on BEIS mandatory climate related disclosure requirements.
12. The FCA consultation papers.
13. The “Dear Chair” letter.