Is Your Board Ready for Compliance with the Disclosure Regulation on Sustainable Finance?

by Reyhan Gulec

                                The regulation on sustainability-related disclosures in the financial services sector (the “Disclosure Regulation”)1  is a part of legislative initiatives (the “Action Plan”) of the European Commission to promote a sustainable economy. The Disclosure Regulation is signed by the European Parliament and the Council of the European Union on 27 November 2019, published in the Official Journal of the European Union on 9 December 2019 and will take effect on 10 March, 2021.

                                 

                                Objective

                                The Disclosure Regulation aims to i) lay down the harmonised rules for financial market participants and financial advisers on transparency with regard to the integration of sustainability risks, ii) the consideration of adverse sustainability impacts in their processes and iii) the provision of sustainability related information with respect to financial products.


                                Who

                                It will apply to AIFMs, UCITS management companies, as well as portfolio managers and investment advisers authorised under MiFID (the “Financial Market Participants”). The Disclosure Regulation obliges the Financial Market Participants to publish on their websites information about their policies on the integration of sustainability risks in their investment decision-making process in order to ensure the transparency of sustainability risk policies.

                                Sustainability risk is defined as an environmental, social or governance event or condition that, if it occurs, could cause a negative material impact on the value of an investment. The sustainability factors that could cause such sustainability risk are environmental, social and employee matters, respect for human rights, anti-corruption and anti-bribery matters. These shall be taking into consideration while considering the below mentioned disclosure on adverse sustainability impact.

                                Please note that despite Brexit, the Disclosure Regulation is decided to be onshored by the UK. The pre-investment disclosure obligations of AIFMs on ESG are based on Article 23 (1) of the Directive on Alternative Investment Fund Managers (“AIFMD”), which applies to EU and the UK based AIF managers. And this obligation apply also to the managers of non-EU AIFs based on cross references to Article 36 and 42 of the AIFMD for the funds they market in EU and the UK under national private placement regimes. This shall mean the pre-investment disclosure obligations also applies to non-EU AIFMs who market their non-EU funds under Article 42 of private placement regimes in the UK or any EU jurisdictions. i.e. Swiss investment fund managers marketing their Cayman island based funds in EU jurisdictions or the UK.

                                Board of Directors’ Take Away Points

                                The Boards of the Financial Market Participants shall consider the following steps in order to allow time themselves to formulate relevant ESG policies and practices tailored to their business and investment objectives.

                                This first set of points is from a macro perspective in order to assess the Boards’ position on strategic decision making for sustainable finance regulatory compliance. 


                                - Start planning the short and long term strategies for ESG compliance
                                - Evaluate whether the Board have any competency regarding ESG matters
                                - Evaluate if the Board composition is suitable for ESG compliance
                                - Evaluate whether the Board needs a sustainability committee
                                - Evaluate where the Board stands in meeting the shareholder value expectations
                                - Evaluate whether the Board have correct information channels to receive accurate data to assess ESG risks
                                - Evaluate in what position does the Board aims to comply with sustainability requirements (i.e. adequately to the minimum for compliance purpose or to follow best market practices, stewardship etc.)

                                These second set of steps is from a micro perspective based on the obligations imposed by the Disclosure Regulation. Please take into consideration these to see how far your Board has progressed within the last 6 months since publication of the Disclosure Regulation and what steps shall be taken within the next 9 months in order to be ready for compliance ahead of the Disclosure Regulation’s effective date:

                                - Start planning both on entity and product level for new ESG obligations
                                - Decide whether the company needs to receive service for ESG consulting to get ready for the whole Action Plan requirements
                                - Fill in the data gap on product level, classify financial products and analyze the underlying economic activities
                                - Draw a roadmap on how to implement the new disclosure requirements
                                - Revisit and adjust investment strategy, thus the policies in place
                                - Reorganize internal processes, risk management and control functions
                                - Negotiate/communicate contractual terms with investors, if need be (i.e. LPAs, IMAs, side letters)
                                - Make strategic business and investor relations decisions to specify how remuneration policies are compatible with the integration of sustainability risks
                                - Evaluate whether the pre-contractual disclosure requirements shall be addressed in offering documents for existing and new products

                                Disclosure Obligations
                                The disclosure obligations are based on a comply or explain basis, which means if the Financial Market Participants prefer not to integrate the sustainability risk into their decision making process then they need to explain the rationale behind their reasoning. This is also a significant point to be taken into consideration from a reputational perspective.

                                Website Disclosures:

                                - Shall be made where the Financial Market Participants consider principal adverse impacts of investment decisions on sustainability factors, a statement on due diligence policies with respect to those impacts, taking due account of their size, the nature and scale of their activities and the types of financial products they make available
                                - information about their policies on the identification and prioritisation of principal adverse sustainability impacts and indicators shall be provided
                                - a description of the principal adverse sustainability impacts and of any actions in relation thereto taken or, where relevant, planned shall be provided
                                - reference to their adherence to responsible business conduct codes and internationally recognised standards for due diligence and reporting shall be made and, where relevant, the degree of their alignment with the objectives of the Paris Agreement shall be explained
                                - the remuneration policies shall include information on how those policies are consistent with the integration of sustainability risks, and they shall publish that information on their websites

                                Firms with 500 or more employees shall publish and maintain on their websites a statement on their due diligence policies with respect to the principal adverse impacts of investment decisions on sustainability factors.

                                Pre contractual disclosures:

                                In terms of integration of sustainability risks the Financial Market Participants shall disclose:

                                - how the sustainability risks are integrated into investment decisions
                                - the results of the assessment of the likely impacts of sustainability risks on the returns of the financial products

                                In terms of promotion of environmental and social characteristics of a financial product the Financial Market Participants shall disclose:

                                - information on how those characteristics are met
                                - if an index has been designated as a reference benchmark, information on whether and how this index is consistent with those characteristics
                                - the methodology used for the calculation of the index in accordance with the technical standards to be completed by Joint Committee of the European Supervisory Authorities

                                With regards to sustainable investments there are also detailed website, pre-contractual and periodic disclosures that shall be made.  For further information please see the Disclosure Regulation2. It should be noted that adverse sustainability Impacts shall be provided both at entity level and product level.

                                Furthermore, a clear and concise explanation for the reasons not including sustainability risk in case deeming that it is not relevant shall be provided for all disclosures. In addition marketing communication shall not contradict with the disclosures made.

                                This regulation shall be read with Taxonomy Regulation due to additional disclosure obligations under the Taxonomy Regulation that will apply to products marketed as sustainable investments and claim to have ESG characteristics. You may see our previous article on the Taxonomy Regulation via the link below3 .



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                                1 & 2 https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32019R2088&from=EN
                                3 https://www.ila.lu/blog/1/post/a-turning-point-in-sustainable-finance-the-taxonomy-regulation-157


                                Written by Reyhan Gulec, Member of ILA’s Sustainability Strategy for Boards Committee.