Environmental, social and governance (ESG) are factors used to assess the behaviour of entities and measure their environmental and social impacts. This is an issue of ever growing importance for asset managers, who are under both direct risk (climate-related disasters impacting commodities and global economies) and indirect risk (changing consumer preferences and increasing scrutiny and pressure by governments and regulators). Industry bodies have also put their weight behind supporting ESG matters, with Chris Cummings, CEO of the Investment Association (IA) stating: “As stewards of the economy, investment managers have an important role to play in guiding the companies we invest in towards a more sustainable future. This is not only in the best interests of our planet, but also for savers and investors seeking long-term returns from their investments.”

  1. The EU Sustainable Finance Action Plan was published in March 2018 with three core objectives: (1) to reorient capital flows towards sustainable investment; (2) to mainstream sustainability into risk management; and (3) to foster transparency and long-termism in financial and economic activity. Building on this, the EU’s renewed sustainable finance strategy was launched by the European Commission in April 2020, aiming to provide a roadmap to increasing private investment in sustainable projects and activities, and supporting the actions set out in the European Green Deal. The strategy focuses on three main areas: (1) strengthening the foundations for sustainable investment by creating a framework with appropriate tools; (2) increasing opportunities to have a positive impact on sustainability for citizens, financial institutions and corporates; and (3) ensuring that climate, social and environmental risks are fully integrated and managed by the financial system as a whole. Further legislation and guidance has been introduced in order to meet these objectives and further the EU’s goal to turn carbon neutral by 2050.
  2. The EU Taxonomy Regulation establishes criteria for determining whether an economic activity qualifies as environmentally sustainable for investment purposes, aiming to encourage investment from the financial sector to companies engaged in or transitioning to more sustainable activities. It outlines six environmental objectives: climate change mitigation, climate change adaption, sustainable use and protection of water and marine resources, pollution prevention and control, protection of healthy ecosystems, and the transition to a circular economy. Under the Taxonomy Regulation an economic activity can be considered environmentally sustainable where it contributes to one of the six environmental objectives, does no significant harm to any other objective, complies with the minimum social and governance safeguards, and complies with the technical screening criteria. The final text of the Taxonomy Regulation was published in the Official Journal in June 2020. The requirements concerning climate change mitigation and climate change adaptation apply from 1 January 2022, while those for the other environmental objectives apply from 1 January 2023. On 20 November 2020, the European Commission launched a consultation on the delegated regulation containing the technical screening criteria for climate change mitigation and climate change adaptation, which set out the conditions under which certain economic activities can qualify as contributing substantially to those two environmental objectives.
  3. The EU Sustainable Finance Disclosure Regulation (SFDR) imposes new disclosure and transparency requirements related to sustainability at both entity and product level for certain financial services providers. In particular, SFDR requires the integration of sustainability risks into investment decision-making and advisory processes, and transparency regarding financial products that target sustainable investments. Specific requirements include pre-contractual disclosures, and disclosures on websites and in periodic reports. It applies to both financial market participants and financial advisers, including Alternative Investment Fund Managers (AIFMs), UCITS management companies and MiFID investment firms carrying out portfolio management and providing financial advice, with in-scope products covering AIFs, UCITS schemes and segregated managed accounts. The European Supervisory Authorities (ESAs) published on 4 February 2021 the final report on draft regulatory technical standards (RTS) on the content, methodologies and presentation of disclosures under the SFDR and submitted them to the European Commission. The ESAs propose in the draft RTS that the application date of the RTS should be 1 January 2022.
  4. The EU Low-Carbon Benchmarks Regulation came into force December 2019 and set out two new categories of benchmark: EU Climate Transition Benchmarks and EU Paris-aligned benchmarks. The requirements apply to benchmarks administrators, so may be applicable to asset managers both where they administer ESG benchmarks underlying passive funds and as users of benchmarks themselves. Benchmarks administrators are required to disclose for every benchmark offered whether such benchmark pursues ESG objectives, which may then prompt asset managers to request such benchmarks in order to match their broader fund objectives. The three delegated acts concerning benchmark statements, methodologies and minimum standards for low carbon benchmarks came into force on 23 December 2020.
  5. Though Brexit and the end of the transition period on 31 December 2020 meant that there was no comprehensive onshoring of the Taxonomy Regulation and SFDR, the UK government has committed to at least matching the key objectives of the EU sustainable finance action plan. The framework of the EU Taxonomy Regulation, including the environmental objectives, will form part of UK domestic law as retained EU law, but not the disclosure obligations and technical screening criteria. The Chancellor of the Exchequer, Rishi Sunak, announced on 9 November 2020 that the UK will implement a green taxonomy which takes the scientific metrics in the EU taxonomy as its basis and a UK Green Technical Advisory Group will be established to review these metrics to ensure they are right for the UK market. The Low Carbon Benchmarks Regulation forms part of domestic UK law as ‘retained EU law’, including the delegated acts underlying the Regulation, which became applicable from 23 December 2020. Most provisions of the SFDR will apply from 10 March 2021 and will not form part of UK domestic law. Although certain provisions of the SFDR applied from December 2019, these have been excluded by UK secondary legislation. Furthermore, the SFDR amendments to MiFID II, UCITS and AIFMD do not form part of retained EU law. The UK government would therefore need to pass specific legislation in order to implement equivalent provisions. Ultimately, there is much speculation, but it remains to be seen how far the UK government will implement or diverge from the EU regulation. It is understood, however, that the FCA and HM Treasury intend to develop UK sustainability disclosure standards for financial services firms in the first half of 2021.
  6. Managers should consider their contractual arrangements with delegated managers, advisers and distributors to ensure compliance with ESG-related obligations. For example, amendments to agreements may be required to ensure out of scope counterparties either contractually apply with relevant requirements or, as a minimum, assist with information, data and documentation provision as necessary to enable managers to comply with their obligations. Managers should also ensure that any public disclosures made are consistent with those of their delegated managers, advisers and distributors, where possible. In this respect, UK managers that are not directly subject to the regulations should still consider performing a scoping exercise where they have cross-border business with EU-based counterparties, fund investors and clients to help anticipate these information requests.
  7. The Task Force for Climate-related Financial Disclosures (TCFD) has provided recommendations for listed companies with regards to disclosure of information on governance, strategy, risk  management, metrics and targets. The FCA intends to apply TCFD to asset managers, and in December 2020 published final rules introducing a ‘comply or explain’ approach to TCFD for premium listed companies. Additionally, in the IA’s November 2020 Climate Change Position Paper, the IA asked the UK government to broaden its stance and require all large companies (public and private) to report in line with TCFD and amend company law to effect this. Chancellor Rishi Sunak also announced on 9 November 2020 that the UK will become the first country in the world to make TCFD-aligned disclosures fully mandatory across the economy by 2025, going beyond the ‘comply or explain’ approach. The cross-regulator taskforce published its interim report with a roadmap for implementing mandatory disclosures, many of which will come into force by 2023. The upcoming rules and regulations will capture a significant portion of the economy including listed commercial companies, UK-registered large private companies, banks, building societies, insurance companies, UK-authorised asset managers, life insurers, FCA-regulated pension schemes and occupational pension schemes.
  8. The EU Non-Financial Reporting Directive (NFRD) requires the disclosure of companies’ social and environmental impact, including disclosure of non-financial and diversity information by large, public interest companies (defined as having over 500 employees). Any large European-based asset managers meeting such criteria would therefore be in scope. The NFRD is under review, and the legislation aims to strengthen access to information while avoiding excessive reporting obligations in order to embed sustainability into the corporate governance framework and ensure that companies focus on long-term development and sustainability, as well as short-term financial performance. The Taxonomy Regulation requires companies subject to the NFRD to disclose the proportion of their turnover, capital expenditures and operating expenditure which is associated with environmentally sustainable economic activities. The requirement to disclose in line with the Taxonomy under NFRD is potentially very significant as it covers a broader range of environmental issues and therefore will provide asset managers with the data to ensure that the full environmental impact of an investment can be assessed. This will be particularly important where an investment could positively contribute to one environmental objective but harms others, e.g. a wind farm which does not have sustainable processes for recycling wind turbines. Asset managers would therefore be able to draw on this mandatory reporting data in order to meet their obligations under the Taxonomy Regulation and SFDR.
  9. The revised EU Shareholder Rights Directive (SRD II) requires asset managers to develop and disclose an engagement policy that describes how they combine shareholder engagement in their investment strategy. ESG issues are central to SRD II, with the engagement policy needing to describe how they monitor investee companies on relevant matters. These include strategy, financial and non-financial performance and risk, capital structure, social and environmental impact and corporate governance, conduct of dialogues, the exercise of voting rights and other rights attached to shares, communicating and cooperating with relevant stakeholders of the investee companies, and managing conflicts of interests.
  10. The revised UK Stewardship Code took effect on 1 January 2020 and places ESG factors at the heart of effective stewardship. Within its 12 principles for asset owners and managers, signatories are required to integrate stewardship with investment, including on material ESG issues. Furthermore, signatories are required to explain how this integration has differed for funds, asset classes and geographies.


Global Director of Financial Services Knowledge, Innovation and Product

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