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SFDR Goes Live

Article featured in Asset Servicing Times.

March 10th marked the implementation of the new Sustainable Finance Disclosure Regulation (SFDR) amid the growing importance of environmental, social and governance (ESG) in financial services.

A wide range of firms are in scope of the regulation including investment firms, portfolio management and pension providers, managers of UCITS and alternative investment funds.

SFDR establishes transparency requirements for financial market participants on the integration of sustainability risks and consideration of adverse sustainability impacts in their processes, and the disclosure of sustainability features of financial products.

“We believe that if done correctly SFDR will help focus efforts more towards sustainable investments,” says Jag Alexeyev, head of ESG insights at Broadridge Financial Solutions.

“By this we mean it will help promote capital flows to businesses that offer solutions to sustainability-related challenges, improve corporate ESG performance, mitigate sustainability-related risks, and potentially strengthen long-term shareholder returns,” explains Alexeyev.

Over the long term, Alexeyev says these developments will offer the potential to create more resilient financial markets and economies which will, in turn, support asset management.

Meanwhile, Justin Partington, group head of funds at IQ-EQ, says that SFDR is set to be a “game-changer” in terms of creating a commitment to consider ESG and sustainability when making investment decisions.

"Publicly committing to a sustainable investment strategy, while once discretionary, is now mandatory for fund managers and will be a big step towards removing the grey area that has plagued the sector over the last decade."

Partington adds: “This is just the beginning of a new paradigm, and we are actively helping our clients navigate this new landscape.”

In terms of how the UK is impacted by this new regulation, Hari Bhambra, global head of compliance solutions at Apex Group, notes that as with any aspect of financial services, the implications of this regulation are global.

Bhambra explains that at first glance, non-EU asset managers could be forgiven for believing they do not fall in scope of the EU SFDR and are dismissing this as not relevant to them.

“However, the SFDR applies to entities operating or managing in the EU or marketing their products into the EU – even if they are headquartered in Asia Pacific (APAC) or the US,” warns Bhambra.

Doing business with any other jurisdiction requires alignment of operations to ensure that there are no competitive disadvantages due to jurisdictional differences, particularly with regards to access to investors and capital.

Apex is currently seeing examples of this with regard to the SFDR and also the post-Brexit financial services regime in the UK.

UK-domiciled managers and advisors wishing to market into the EU will have to ensure SFDR aligned disclosures and may elect to modify their investment or product governance process.

“This is particularly with regards to any fund that is seeking to raise investment from the EU given that EU financial market participants (FMPs) and financial advisers (FAs) will be actively disclosing how sustainability risks are integrated into their processes - investors may choose to select only those managers which have adapted their investment process accordingly. Providing product level disclosure alone may not be enough in the future,” says Bhambra.

Broadridge’s Alexeyev adds that most of the largest UK firms will continue to sponsor funds through EU structures such as UCITS and they will in practice comply with SFDR.

The regulation will also apply to a UK firm that markets funds in the EU through national private placement regimes under the Alternative Investment Fund Managers Directive (AIFMD).

In addition, companies that provide investment management or advisory services to an EU firm that is in scope of SFDR will also most likely be asked to provide disclosures, according to Alexeyev.

Alexeyev comments: “Others in the UK may voluntarily choose to offer ESG disclosures aligned with the SFDR if it becomes a due diligence norm among enough fund selectors, wealth managers, and institutional investors.”

Discussing whether or not the UK will come up with its own version of the regulation for firms operating domestically, Bhambra highlights it is anticipated that the UK will adapt the Financial Stability Board Task Force on Climate-related Financial Disclosures (TCFD).

The treasury has identified a five-year staggered timeline for the implementation of equivalent disclosures from listed entities across the UK asset managers.

Bhambra suggests in order to remain competitive and to optimise access to global capital, the UK, like any other jurisdiction whose financial institutions need to access global investors, will need to consider a regime that is equivalent, as it may be more challenging not to.

Alexeyev also affirms that the UK government has stated its intention to support a “green industrial revolution” and is planning for mandatory reporting of climate-related financial information in line with the TCFD.

Beyond climate-related disclosures, Alexeyev believes, the government also has plans to implement its own green taxonomy which would identify environmentally sustainable activities.

“It appears that the UK will attempt to create sustainable finance regulation that addresses similar issues and goals as the EU regulations. As a template already exists, the goal seems achievable with industry feedback. Since most large UK asset managers also operate across Europe, they might choose to adhere to the highest common standards that emerge on either side of the channel,” he outlines.

Applying to any UK fund or investment manager operating within the EU, the regulation requires market participants to demonstrate that their investment methodology and the assets into which they invest meet the stringent requirements set out in the legislation and are truly ‘green’.

Patric Foley-Brickley, managing director, Maitland Institutional Services, adds: "Those purporting to follow an ESG driven investment philosophy are required to comply with the full extent of the reporting obligations to adhere to the regulations – there are no half measures."

“Over time, it is likely that following an ESG standard may become an inherent requirement for investors. Therefore, it is important that fund practitioners understand the implications of the legislation, and ensure they are ready to meet the additional reporting and regulatory demands that operating ESG funds will entail,” concludes Foley-Brickley.

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