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Julie Becker of the Luxembourg Stock Exchange (seen during an interview in 2019) says EU sustainable investment reporting processes are still at “an early stage”. Photo credit: Mike Zenari 

Already since 2018, the EU’s non-financial reporting directive (NFRD) requires firms with more than 500 employees to make a range of disclosures about the way they operate and manage environmental, social and governance (ESG) challenges. The aim of this directive to to give added information to investors, consumers and policymakers, thus giving businesses an incentive to meet ESG best practice.

Wide scope, work to do

A similar approach is being extended to financial businesses and products under the sustainable finance disclosure regulation (SFDR). Here too, all asset managers and pension funds with over 500 employees (even if they don’t have an ESG investment strategy) will have to make these entity-level ESG disclosures. Specifically this will relate to factors such as carbon emissions, impact on biodiversity, the gender pay gap, the human rights policies of the companies in which they invest, anti-corruption practices and so on. As well, there will be product level disclosure of the sustainability characteristics or objectives of funds.

Hence this will affect fund managers and fund products, be they Ucits funds designed for retail investors, or alternative funds destined for sophisticated clients. It also affects financial advisors. The deadline for compliance is short. The SFRD is currently in its consultation phase, with the European Commission set to finalise these rules and technical standards in December, with implementation of the first phase planned for 10 March 2021. This will require pre-sale and updated documentation to report on these elements.

Taxonomy next

An extra layer of sophistication will be added in 2022 with the advent of the investment classification system or “taxonomy” which is currently being worked upon by the European Commission. Asset managers with an ESG investment strategy will have to disclose the percentage of their investments which conform to this taxonomy, or issue a disclaimer saying their fund does not monitor these factors. There will also be a low carbon benchmark regulation which will seek to provide greater clarity about how ESG investing benchmarks and ranking systems are created. Luxembourg’s fund domicile hub would be the logical place to base the expertise needed to put these rules into action.

The Association of the Luxembourg Fund Industry has yet to form a common view of these complex matters, other than saying it “actively supports the initiative of the European Commission to promote sustainable finance and welcomes the consultation on the renewed sustainable finance strategy.”

The Alternative Investment Management Association, which represents the global industry, warned that important though sustainability is, it is not always an over-riding concern, saying: “diversity and heterogeneity of alternative investment strategies should be taken into account.” In other words, investment markets provide entrepreneurs with the funding they require to develop their ideas, and excessively heavy ESG policy concerns might hamper this process.

Make it useful

For Julie Becker, deputy CEO of the Luxembourg Stock Exchange and founder of the Luxembourg Green Exchange bond listing hub, implementation of these new rules “is still unchartered territory and more guidance is needed, especially in terms of harmonising the scope of different reporting frameworks. We are only at an early stage of the process.” So while welcoming the overall approach, she insists that “we need to make sure that reporting does not only become a reporting obligation for product managers but that this reporting produces information which is meaningful and usable by investors.”