Peter Dunbar and Simon Whistler, Senior Specialists, Private Markets, PRI
The EU’s Sustainable Finance Disclosure Regulation (SFDR) is part of the European Commission’s Action Plan on sustainable growth and came into effect on 10 March 2021. It applies to financial market participants across all asset classes, including private equity and infrastructure funds.
The regulation intends to make the sustainability profile of funds easier to understand, more comparable, and avoid greenwashing. It does this by placing funds into several specific categories and promotes transparency by prescribing set ESG metrics to disclose principle adverse impacts (PAIs) on sustainability factors.
The regulation also requires GPs to disclose how their remuneration policies are consistent with integrating sustainability risks.
The PRI recently released an investor briefing looking at the key features of the SFDR and the disclosure requirements in detail.
With the one-size-fits-all nature of a regulation that transcends multiple asset classes, certain private markets’ specific characteristics bring unique challenges to implementation. In particular, the general dearth of data in private equity and infrastructure and a culture that has historically not been known for transparency.
We are now past 10 March 2021 and have more certainty around the disclosures required, so what has been the reception to the regulation within the private markets industry and what are the issues still to be faced?
A missed opportunity?
For ESG, legal, or compliance professionals at GPs or their outside counsel, the last six months have been challenging. The EU’s understandable desire to move rapidly on the sustainability agenda and regulation has undoubtedly been a partial cause for the issues that have beset the process and the angst this community has felt given a lack of technical guidance. Different private markets players we’ve spoken to talk of a “missed opportunity” with the implementation of the SFDR to this point.
Much of this is centred around the regulation’s product-level disclosure requirements. Specifically whether and how organisations should make various disclosures under the regulations various articles, in the absence of real clarity on what each implies and their underlying Regulatory Technical Standards (RTS). For example, we’re aware of managers who would otherwise wish to be seen as leading players on ESG and sustainability but are holding off disclosing under Article 8 (for products which “promote environmental and/or social objectives”). This is because there’s no clear definition on what “promote” means in this context and the RTS have not yet been finalised.
There’s further caution in the industry due to uncertainty about how regulators in different countries will police the regulations. As one example, Denmark’s Financial Supervisory Authority (FSA) has set up a new unit to monitor investor’s disclosures under the SFDR, and will have authority to act against alleged greenwashers. But elsewhere the picture is less clear – and indeed, regulators themselves are still waiting for full guidance from the EU Commission.
Industry is still supportive
Despite these challenges, most in the private markets industry remain supportive of the SFDR’s aims. Leading practitioners see the regulation, together with the EU’s Sustainable Finance taxonomy, as a potential gamechanger, on a different scale to what has been proposed and enacted previously in sustainable finance. Indeed, frustration with the process so far is probably intensified precisely because those with more advanced ESG practices and those who actively promote a sustainability agenda are keen to see their efforts ‘rewarded’ and so-called greenwashers forced into more concerted action.
There’s also optimism that the SFDR will have its intended effect in the longer term. Already, there may be signs that the SFDR is pushing laggards in the right direction. Organisations that we have consulted over the past few months suggest that the regulation has driven sustainability further up the agenda of firms that previously had paid only lip service to the issue. Moreover, a broader and more consistent approach to data-gathering at portfolio companies and assets can only help improve transparency around sustainability factors.
Grounds for optimism
Given the step-change in sustainability practice that the SFDR seeks to drive, some bumps in the road were perhaps inevitable. The clock is also ticking for updates to the RTS that will underpin the next stage of disclosures under the regulation, from early 2022. Here, the hope is that there will be closer alignment between the final RTS and the EU taxonomy to ensure greater consistency between the two and avoid further burdens on investors.
But this is also about the bigger picture: a clear direction of travel on sustainable finance is being set, not just in the EU but increasingly on a global basis. The PRI noted over 120 new or revised policy instruments around the world related to sustainability in 2020, a new record for a single year, and 30% up on the total recorded in 2019.
That’s not to say that all jurisdictions are moving at the same pace, or from the same starting point, as the EU. Nor does it mean that every instrument will be effective, or be without its challenges in implementation, like the SFDR. But it sends the message to private market’s investors that current challenges around the SFDR should be worth overcoming, as the groundwork for more concerted efforts to drive sustainability standards and tackle greenwashing is laid.
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