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Sustainable Finance: the regulation clock is ticking, little time left to take strategic decisions

The past few years have witnessed an unprecedented rally from investors towards Environmental, Social and Governance (ESG) investments and funds, representing a profound shift in investors’ expectations. Investors no longer focus on financial performance only, they are eager to ensure that financial returns are not obtained at any cost, and that the investee companies have good ESG practices.

The shift has occurred as EU citizens increasingly recognise the importance of reducing their environmental impact alongside the growing urgency of addressing the climate change issue, aiming at embedding sustainability consideration in all aspects of their life, from consumption to  investment.

Concurrently, the increased availability of ESG data and benchmarks have clearly demonstrated that integrating ESG matters into the investment decision process is not at the expense of the financial return. Indeed, to the contrary, ESG consideration allows investors to identify and address sustainability risks upfront, and companies with good ESG scoring tend to be less volatile, as witnessed by the relatively good performance that such companies exhibited during the very volatile markets period at the beginning of the COVID-19 lockdown.

In this context, successful market players are those that are able to adapt their strategy, processes, product offering and corporate messaging to duly reflect that ESG is no longer a niche strategy, but a mainstream component of investment advice and investment products.

The implementation of the upcoming EU regulations, stemming from the EU Sustainable Finance Action Plan, will further accelerate the transition towards sustainable investing, as even the most ESG agnostic investors will have no choice but to consider ESG risks in their investment process.

The Sustainable Finance Action Plan has three main objectives:

  • Reorient private investments towards financing sustainable activities - starting with defining environmentally sustainable activities (the Taxonomy regulation), defining ecolabels for financial products and climate change benchmarks;
  • Ensure that sustainability risks are adequately captured, assessed and considered throughout the investment process;
  • Foster more long-termism and transparency on sustainability within the investment and advice process (the "Sustainable Finance Disclosure Regulation" or SFDR).

From early 2021, all those providing investment advice and portfolio management (asset managers, private bankers, insurers, pension providers, intermediaries…) will be required to:

  • Provide more transparency on how they consider ESG risks in all their investment decision/advice;
  • Align their remuneration policies accordingly;
  • Provide more transparency on how they consider the negative impact that companies in portfolio could have on environment or social matters;
  • Review their product strategy and classify their financial products according to three main categories (and adapt their offering documents and website accordingly):
    1. Non-ESG products (these products will anyway be required to consider ESG risks in the investment decision under article 6 of SFDR);
    2. Products promoted as ESG (article 8 of SFDR): these products follow a binding investment process restricting the investment universe, based on environmental or social characteristics;
    3. Sustainable investments (article 9 of SFDR): these products have to deliver a positive impact on environmental or social objectives.
  • Ensure that the sustainability preferences of their investors are duly captured and matched with the product offering;
  • Adapt internal processes (investment, compliance, risk management, distribution, product launch, reporting…);
  • Establish a new data approach in order to acquire, validate and activate the new data fields required to satisfy the new transparency requirement (ESG risks, impact indicators, taxonomy alignment…);
  • Upskill the entire staff within the organisation, to ensure that all departments are up to the challenge.

Implementation will be really challenging as the regulations are rather complex, the timeline is short, and the data challenge is particularly acute as the data required to satisfy the new requirements are not yet available on the market.

All Alternative Investment Fund Managers (AIFM) and Alternative Investment Funds (AIF) fall under the scope of SFDR, which will apply from 10 March 2021. So, the clock is ticking…

Immediate actions required from AIFM include strategic decisions as to how the funds will be positioned vis-à-vis the new categories of products as per the regulation, taking into consideration the existing process, what is feasible in terms of available data, and the investors’ sustainable preferences, as the product alignment will be a key success factor in future fund raising.

Managers could be tempted to wait for further clarity to be shed by the expected Regulatory Technical Standards (RTS) – but these are not expected to be finalised on time for the deadline of 10 March, 2021 and there is no indication that this date would be postponed. We can therefore expect a staged implementation:SFDR on 10 March 2021, SFDR RTS a few months later, AIFMD and MiFID2 changes in 2022, taxonomy in 2022/2023…

Navigating through such complex matters will not be an easy task – it nevertheless remains critical to keep in mind the strategic aspect of the choices made and the decisions taken, the need for a strong tone at the top to obtain the adherence of the staff, and the pervasive impact on the operations across the organisation.

Contact us

Nathalie Dogniez

Sustainable Finance Leader, PwC Luxembourg

Tel: +352 49 48 48 2040

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