Sustainability risks – financially material impacts
In order to act in the best interests of their clients, Financial Market Participants and Financial Advisors should assess the likely impacts of sustainability risks on the financial return of financial products in a systematic way (i.e. integrate it in their due diligence and research processes on a mandatory basis).
The EU regulator expects asset managers to assess sustainability risks continuously and apply this on a best effort basis to all asset classes. The proper management of sustainability risks becomes even more important with the increasing risks related to climate change. Therefore, over time sustainability risk integration can be expected to become the new normal in the EEA asset management market.
The SFDR provides for the option to explain why sustainability risks are not relevant and thus do not need to be considered (comply or explain). However, in most cases this would not be a prudent approach and may be considered a breach of fiduciary duties of asset managers. Not considering risks related to climate change, for example, does not seem to be an option given the effects of climate change that we are already experiencing. Therefore, integrating sustainability risks in the investment decision process will become the new baseline expectation from both regulators and investors.
Principal adverse impacts (PAI) – footprint / active ownership and engagement
The SFDR also requires asset managers to disclose their policies regarding the consideration of principal adverse impacts (PAI) of investment decisions on sustainability factors on a “comply or explain” basis. In a PAI statement, they should describe their due diligence policies regarding PAI, provide summaries of their engagement policies and how they discharge their stewardship responsibilities regarding the negative impact or footprint of their investments. Qualitative (narrative) disclosures should also include references to compliance with business conduct rules and international standards, e.g. Task Force on Climate-related Financial Disclosures (TCFD), Principles for Responsible Investment (PRI) and OECD due diligence guidance.
The draft RTS proposes a very granular template-based description of the PAI based on up to 50 quantitative key performance indicators (KPIs). Of these, 32 are mandatory and the remainder are optional. Asset managers face real challenges in obtaining all relevant ESG data across all financial products. It remains to be seen in Q1 2021 whether the pushback from the asset management industry to this draft RTS proposal will have an effect and whether full transparency will nevertheless need to be provided.
At this point in time it is assumed, due to the generally increased ESG data need and political pressure on delivering the EU Green Deal, that a large part of the quantitative KPIs will remain, especially those related to environmental data as well as the general aim to link PAI to measurable KPIs.
Asset managers with more than 500 employees as a parent of a group will have to start considering PAI on an entity level as of 30 June 2021. Others below this threshold may choose not to comply. This non-compliance must be made transparent on the website and should include a statement that the entity does not consider PAI (their investment footprint) along with a clear explanation why it does not do so. It will be a strategic decision whether asset managers choose to opt in on an entity level or to issue such a statement, with key decisive factors being the sustainability ambition of an entity and / or pressure from their various stakeholders. By 30 December 2022, this decision will have to be made on a product level as well.