2024 has seen significant developments for European sustainability regulations, both at an EU and national level. In this article we explore the latest regulatory developments and the growing need for asset managers and owners to implement robust investment compliance monitoring
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On 13 May 2024, the European Securities and Markets Authority (ESMA) published its guidelines on fund naming.[1] The guidelines aim to protect investors from greenwashing risk and set out new minimum standards for funds that use terms such as ESG, green, impact or sustainability in their names, to ensure they are not intentionally or unintentionally unfair or misleading for investors.
The guidelines, which must now be adopted at national level, will apply from 21 November 2024 for new funds. Existing funds have a nine-month transition period in which to change the name or adjust their portfolios.
Continuing the scrutiny on greenwashing, on 4 June 2024 the European Supervisory Authorities (ESAs) issued their Final Reports on Greenwashing in the financial sector.[2] To ensure financial market players provide sustainability information that is fair, clear and not misleading, the ESAs stressed the need for firms to “adapt their governance and processes (e.g., regarding risk management, due diligence controls over ESG information, validation of marketing messages, remuneration policies), build expertise, upgrade their data infrastructure, and uphold comprehensibility for consumers.”
EU launches review of SFDR
On 18 June 2024, the ESAs issued their latest review of the SFDR.[3] In this ‘Opinion’, the ESAs recommends introducing a new product classification scheme, replacing the current SFDR Article 8 and 9 designations with at least two new ‘sustainability’ and ‘transition’ categories aimed at avoiding the use of misleading product names and helping consumers better understand their underlying sustainability profiles. A further recommendation highlighted the need for a consistent definition of “sustainable investment.”
Ensuring fund names, strategies and portfolio components are reconfigured in line with the emerging requirements will pose huge tests for market participants. As well as meeting their existing SFDR responsibilities, firms must keep track of and prepare for the changes ultimately introduced under SFDR 2.0, along with new EU measures on greenwashing.
Discrepancies between the SFDR and MiFID – which mean an SFDR-compliant product is not necessarily a MiFID-compliant one – add to the complexity. Sales and marketing processes will need to ensure the right products with the right features are sold to the right person based on their ESG preferences as defined by MiFID. Asset managers with cross-border product ranges may also need to comply with the SFDR and/or legal frameworks in APAC that have no direct interoperability with the different EU versions.
Institutional investors will have some time to adapt to these potential changes. The SFDR review will need to go through the legislative process, involving the European Parliament and Council, and is therefore not expected to enter into application before at least 2027.
In addition to the potential evolutions of SFDR and wider sustainability frameworks, now, some national regulators are pursuing their own regimes of local supervisory proposals and actions.
France’s Autorité des Marchés Financiers (AMF) has been at the forefront of the SFDR revisions debate as it pushes for extensive amendments to the regulation. In a position paper published in February, the AMF proposed four wide-ranging product categories based on objective minimum criteria designed to leave no room for interpretation:[4]
- Environmental solutions.
- Social solutions.
- Climate transition.
- Non-financial filters.
Provided products meet the minimum criteria, firms would have flexibility to develop more ambitious strategies and practices as points of differentiation. Products with sustainability-related claims would be subject to mandatory disclosure requirements on a limited set of indicators “to foster comparability between products while being understandable to retail investors.”
Meanwhile in Luxembourg, in 2023 the Commission de Surveillance du Secteur Financier (CSSF) published its Thematic Review on the implementation of sustainability-related provisions.[5]; This stipulates that “funds shall comply on an ongoing basis with all binding commitments of their respective investment strategy as disclosed in their offering documents/prospectus, including the precontractual disclosures (i.e. minimum portion of sustainable investments)”. IFMs remain entirely responsible for ensuring compliance with all sustainability-related provis
The growing need for ESG investment compliance
To comply with these new regimes firms will need to monitor the relevant investment restriction rules on an ongoing basis and maintain a robust control framework.
In practice, this is a considerable undertaking for many asset managers and owners. For example, an AMF Supervision of Operational and Thematic Practices (SPOT) study found that 77% of French respondents were still using manual controls, which are linked to a higher risk of error and failure to identify potential breaches.[6] BNP Paribas’ Global ESG survey revealed nearly two-thirds of asset managers and asset owners have not yet integrated ESG expertise and data into their investment compliance.[7]
Asset managers and owners must take a four-pronged approach to develop robust investment compliance
Governance – the first step is to define what compliance entails and what is needed to achieve it. The focus should be on implementing a governance structure and processes able to deliver truly aligned ESG/sustainability investments to investors.
Systems – Manual compliance processes expose firms to human errors and oversight. Automated monitoring – using either vendor software or in-house systems – can increase efficiencies and free firms to focus on any breaches or potential issues. Proprietary technology builds allow firms to maintain control and create bespoke capabilities matched to their circumstances. But developing a fit-for-purpose solution and connecting to the necessary ESG data sources is expensive and requires specialist expertise.
Data – Full data coverage depends on connectivity to multiple data providers. The different data inputs will need to be cleansed and normalised. Data quality should be monitored on an ongoing basis.
People – Complying with the various ESG regulations requires expert people who understand the rules and their firm’s specific responsibilities. It requires IT developers, and data experts to identify the data points that need to be mapped and vendors that can supply them. Subject matter experts who understand what impact ESG and transition risks can have on portfolios are also needed to integrate those risks into risk management processes.
The benefits of outsourced ESG compliance monitoring
As country and EU-level sustainability regulations become more complex, asset managers and owners need greater resource and expertise to monitor investment compliance controls across multi-jurisdictional fund ranges. Since 2023, BNP Paribas has incorporated ESG criteria into our investment compliance screening capabilities, to support institutional investors in monitoring ESG-based rules across a range of fund types and asset classes.
Our fully-automated solution manages the entire process from data acquisition to rule monitoring and alert reporting. More than 1,600 data points, spanning everything from ESG ratings and carbon metrics to sustainable debt data and the EU Taxonomy, are currently available in the solution. We are constantly in dialogue with market-leading data providers and are continuing to add new data providers and data points to our systems
Automating the end-to-end ESG control workstream in this way offers asset managers and owners immediate process efficiencies and the scalability to accelerate their sustainability ambitions. Our large network of ESG and investment compliance specialists can provide asset managers and owners with the expertise they may not have in-house. In a space marked by rapid development and regulatory change, clients can have confidence that screening rules and data feeds will be continuously updated to address new requirements and best support users in their sustainable finance journey.
[1] Final Report: Guidelines on funds’ names using ESG or sustainability-related terms, European Securities and Markets Authority, 14 May 2024
[2] ESAs call for enhanced supervision and improved market practice on sustainability-related claims, European Securities and Markets Authority, 4 June 2024
[3] Joint ESAs Opinion on the assessment of the Sustainable Finance Disclosure Regulation (SFDR), Joint Committee of the European Supervisory Authorities, 18 June 2024
[4] Towards a review of SFDR, Autorité des Marchés Financiers, 20 February 2024
[5] CSSF Thematic Review on the implementation of sustainability-related provisions in the investment fund industry, Commission de Surveillance du Secteur Financier, 3 August 2023
[6] Summary of SPOT inspection on compliance with non-financial contractual commitments by portfolio asset management companies, Autorité des Marchés Financiers, 12 June 2023
[7] ESG Global Survey 2023: Taking Action: Institutional Investors Progress on the Path to Sustainability, BNP Paribas’ Securities Services, September 2023