SFDR and Asset Allocator. The European Green Deal declared climate change and environmental degradation as an existential threat to Europe and the world. The European Union (EU), under its 2018 Sustainable Finance Action Plan, has set out to mobilize private financial capital flows for green investment. One pillar of the EU Action Plan is the ‘SFDR’ or ‘Sustainable Financial Disclosures Rule’, first adopted in November 2019 with the publication of general rules (the so-called Level 1 rules).
January 1, 2023 SFDR in full effect. From 1 January 2023, the SFDR transition period will end and the second round of regulation will come into effect (Level 2), putting the full burden of SFDR on asset allocators, fund managers and portfolio companies.
A US fund manager raising funds in the EU for deployment in the US. US fund managers raising capital in Europe will be required to disclose how they are ‘green’ and/or ‘social’. In the fund industry, mandatory disclosures under the SFDR must be made at the manager level (e.g., via the manager’s website, pre-contractual disclosures to investors such as private placement memorandums, periodic reporting, etc.). channel of the asset manager) and at the product level (e.g. the fund’s investment strategy). SFDR can be viewed as having two objectives: (1) to eliminate “greenwashing” and (2) to encourage “green” and/or “social” investment. A range of entities and products well beyond the investment management industry (including insurance and banking).
Article 6.While Articles 3 and 4 deal with manager disclosures and Article 5 relates to manager remuneration policies, Article 6 of the SFDR serves as a product-level disclosure regime. Article 6 allows companies, products or funds to disclose that they do not intend to contribute to the EU’s efforts to combat climate change. All financial services companies or funds are required to be transparent about their level of commitment to sustainability under Article 6 of the SFDR, but do not aim to combat adverse environmental, social or governmental impacts The company is now identified as a “Article 6” company. The Article 6 declaration of deeming sustainability risks to be ‘irrelevant’ (and why they are irrelevant) was a positive move for companies at the time of the advent of SFDR, but the ‘irrelevant’ position , has rapidly become unattractive to institutional investors within the EU. US fund managers and EU asset allocators raising money in the EU are looking for a commitment to ‘ESG’.
Main adverse effects (Article 7 of the SFDR). At the heart of the SFDR initiative is identifying and disclosing whether and how financial instruments (including funds) consider major adverse impacts on sustainability factors (“PAIs”). The concept of doing After a series of delays, the PAI report will go into effect on January 1, 2023.
In the absence of a statement that PAI is not considered (and that this alternative is available to the fund), a considerable task awaits any product or fund that does consider PAI. (including formulas for measuring greenhouse gas emissions) plus 18 optional environmental or social factors.
Article 8. Article 8 companies shall at all times promote good governance, promote one or more social or environmental characteristics, report on those characteristics and implement SFDR in accordance with Annex 2 of the revised technical standards. We aim to quantify our commitment to those characteristics by completing the adopted disclosure form.
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Sustainability risks are considered relevant to Section 8 products and funds and therefore Managers are required to disclose how the product or fund assesses those risks.
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Similarly, Article 8 products or funds must disclose information about how they promote environmental or social attributes.
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In any case, investments should be made in companies that follow good governance practices. More on this topic below.
Article 9. It includes an explanation that Section 9 products and funds should have sustainable investing as part of their purpose and that purpose should be achieved. A benchmark to the EU climate transition benchmark is expected, but there is no benchmark to the EU Paris aligned benchmark.
Taxonomy. Taxonomy rules establish criteria for determining whether an economic activity is considered environmentally sustainable, with the aim of establishing the extent to which an investment is environmentally sustainable. Taxonomy rules provide definitions and disclosure regimes for giving meaning to specific environmental objectives. (b) adaptation to climate change; (c) sustainable use and protection of water and marine resources; (d) Transitioning to a circular economy. (e) Pollution Prevention and Control. (f) protection and restoration of biodiversity and ecosystems;
What do you mean? Recall that Article 8 and Article 9 funds must invest in portfolio companies that demonstrate good corporate governance. SFDR itself does not prescribe good corporate governance. However, “good corporate governance” appears to be finding some of its meaning in new proposed regulations on corporate sustainability due diligence.
Business companies are subject to the EU Corporate Sustainability Due Diligence Directive. On 1 December 2022, the European Council adopted a draft framework for a Directive of the European Parliament (“Corporate Sustainability Due Diligence Directive”) implementing a new definition of corporate fiduciary duty. Incorporating sustainability elements and risks into corporate due diligence is a long-standing goal of the EU’s Sustainable Finance Action Plan.
Overview. The Corporate Sustainability Due Diligence Directive sets out rules and obligations for private companies regarding actual and potential adverse human rights impacts and adverse environmental impacts. Whilst the Directive itself has a direct impact on the business, it also provides the covered business with an impact upstream and downstream in the value chain, i.e. the ‘chain of activities’, or more precisely the ‘entities with which the business is involved’. Forces consideration of the value chain operations performed by established business relationship. The impact of the inevitable implementation of this Corporate Sustainability Directive will be felt around the world and will affect all US companies operating in Europe or being business partners of European companies.
Mandatory climate change initiatives. A large EU company with 500 employees and a global turnover of €150 million has to deal with climate change. To limit global warming to 1.5°C, in line with the Paris Agreement and the goal of achieving climate neutrality by 2050.
Some non-EU companies are eligible. Non-EU companies generate €40m, at least €20m of which is from ‘High Impact Sectors’ or generate €150m in the EU for the second consecutive year in the previous financial year If so, you will be eligible.
The basics of mandatory due diligence. The due diligence process laid down in this Directive should cover the six steps defined in the OECD Due Diligence Guidance for Responsible Business Conduct. This includes due diligence measures for companies to identify and address adverse human rights and environmental impacts. Under draft Article 4 of the new Directive, this includes the following steps: (d) establishing grievance procedures; and (e) monitoring the effectiveness of measures.
Business partners with contractual obligations. The obligations to in-scope companies seem daunting, not only in terms of the obligations they impose on their own business under their own policies, but also the obligations they impose contractual obligations on their business partners. Article 12 proposes that the EU Commission should develop model contractual clauses for EU companies to implement with their business partners.
Responsibilities imposed on EU companies. Responsibility to regulators and civil liability are those of any large EU country that intentionally or negligently failed to take appropriate steps to prevent or adequately mitigate the impact of a potential adviser or to end an identified adverse effect. It is considered with respect to the company’s own activities.
Financial business: Funds, their managers and asset allocators are also subject to the new sustainability directive. As the Council draft provides that “Member States may decide to apply this Directive to their pension institutions” (Article 2(6) of the draft), all Member States should adopt the Corporate Sustainability Directive. It is not clear whether it should apply to financial services companies. It alludes to the extent of possible EU-wide “opt-in” or “opt-out” to “regulated financial undertakings…” (Article 2(8) of the draft).
Subject to a new Directive by Member States, large fund managers must consider financial service recipients to be within the manager’s “line of activity” and large firms receiving financial services within the scope of the Corporate Due Diligence Directive. For example, the borrower is included in the lender’s “chain of activities”.
“Regulated financial businesses” that may be caught up in the new corporate due diligence directive include credit institutions, fund managers (called AIFMs), insurance and reinsurance companies, and pension funds. This is likely to affect the allocation of assets from target companies to investee companies. If the draft is adopted as proposed, the decision to apply or not to apply the new Directive to financial services firms appears to be left up to Member States as part of their transition process.
Next step. The current text, drafted by the Board, is a “negotiating position,” but one that is well advanced and likely to emerge from Congress to transition to local law in the foreseeable future. seems to be: see here.
