Defining a "sustainable investment"
Effectively evidencing what qualifies as a “sustainable investment” is an essential step in implementing the EUT and Level 2 SFDR requirements. However, definition variations across SFDR and the Taxonomy are proving a blocker.
Tip: Form a view of what “sustainable investment” means for your firm. Look to guidance such as the Regulatory Technical Standards (RTS) under SFDR, which have been updated to include Taxonomy-related disclosures, as well as market insights for inspiration.
EU Taxonomy - Will it really meet its objectives?
The EUT’s objective is to drive capital flows towards companies and projects that are sustainable and minimise impacts. However, due to the expected low alignment of funds against the EUT, there are concerns that this may render Taxonomy alignment a meaningless data point.
Tip: To protect your funds, ensure a Marketing strategy is implemented alongside the Taxonomy to articulate what is at the root of low alignment and the firm’s engagement approach to gradually increase alignment. Understand investors’ expectations around Taxonomy alignment reporting at fund and segregated mandate level.
ESG Data is not where it needs to be
Major challenges are emerging relating to limited ESG data availability, as well as conflicts between proprietary vs external provider scores, issuer hierarchy and data integrity.
Tip: Start vendor selections sooner rather than later, and work with your ESG data providers to understand their data collection, quality management, instrument allocation and scoring processes.
Reporting: How to make it meaningful
SFDR introduces disclosure requirements on ESG topics which are likely to be new for investors. It will be crucial to ensure investors understand what concepts like Principle Adverse Impacts (PAIs) mean, that they can see intentionality in progress on metrics and that they can see how asset managers are responding where expectations are not being met.
Tip: The quality of your reporting will signal your commitment to RI. Think carefully about report design and production to ensure you can provide clear and insightful reporting to clients. Those firms that can offer mass customisation will lead the way.
No-one is thinking about the control environment...yet!
The definition of new monitoring processes across the first line and second line to implement SFDR and the EU Taxonomy should not be underestimated, as well as agreeing ongoing resourcing.
Tip: Make sure that Risk, Compliance and Product control functions are granted access to the right tools that enable tolerances and limits to be set and monitored against and ensure exceptions are escalated using a formal governance process.
Timelines are creating significant resource pressures
The implementation timelines for SFDR and the EU Taxonomy remain incredibly tight; using ‘side of desk’, generalist resource is no longer a viable option.
Tip: Whilst potential delays to deadlines may alleviate this burden somewhat, do not take your foot off the pedal. Ensure you have an effective project management team, access to sufficient subject matter expertise, a formalised governance structure and explicit ownership to drive momentum.
Cross-functional depth of ESG knowledge and ownership has a long way to go
SFDR and the EU Taxonomy are highlighting the need for ever increasing levels of ESG/RI knowledge and a cultural change in the way Product, Investment and Reporting teams own and engage with their clients on RI and associated regulations.
Tip: Focus training efforts on the commercial importance of RI and new product classifications, recruit dedicated specialists to embed ESG/RI into BAU activities and ensure your governance structure embeds accountability in the right areas of the business, not just with Compliance and Central ESG!
Don’t forget the MiFID II suitability assessment
Whilst product classification is helping to ensure investment products “do what they say on the tin”, incoming changes to MiFID II are going to require wealth and asset managers to ensure customers’ sustainability preferences are explicitly identified and thoroughly understood. This will be no small feat!
Tip: Ensure your sustainability suitability assessment process is applied across your customer base, can withstand regulatory scrutiny and demonstrably informs your portfolio construction, investment processes and product strategy.
Are Article 8 products becoming the new de facto?
Market standards are evolving rapidly with a growing view that Article 8 products will become the new de facto standard in EMA. This is putting significant pressure on product conversion processes and new product development strategy to retain AUM, as well as to win new business.
Tip: Identify immediate tactical product upgrades where AUM is most at risk. Define a client engagement strategy to clearly communicate your product conversion roadmap to clients. Ensure clear Article 8/9 thresholds are embedded in new product innovation processes.
Extracting sustainable, strategic advantage from SFDR
SFDR and the EU Taxonomy represent major commercial opportunities for those who develop market leading RI propositions over the next twelve to eighteen months.
Tip: Don’t just focus on Article 8 products; build demand for Article 9 products and differentiate your business through ESG integration and world class reporting capabilities. Engage proactively with your clients and communicate a distinguished, ESG/RI driven performance philosophy and stance.
To find out more about the implementation challenges of SFDR and the EU Taxonomy we are seeing across the market, and how this may impact your business, please contact Sarah Hedges or Troy Mortimer for more information.