Our expert Luxembourg panel, including M&G and Generali Investments, hears how the EU sustainable investment rules caused firms to reflect over the credibility of ‘green’ products. The discussion also centres on the Eltif’s merits and AIF/Ucits convergence.
- Marc-André Bechet, Deputy director general, Association of the Luxembourg Fund Industry (Alfi)
- Micaela Forelli, Managing director Europe, M&G Investments Luxembourg
- Mathieu Maurier, Country head, Societe Generale Securities Services (SGSS), Luxembourg
- Mattia Scabeni, CEO, Generali Investments, Luxembourg
Funds Europe – Greenwashing is a key risk for fund managers. Guidelines exist in Luxembourg that are intended to reduce this risk. Tell us, then, about the Grand Duchy’s anti-greenwashing initiatives.
Marc-André Bechet, Alfi – What the industry does not want to see are national regulations that overlap with the European framework in such a way that would result in more fragmentation and confusion. That could even increase the risk of greenwashing – and so, consequently, there is no ‘gold plating’ of anti-greenwashing regulation in Luxembourg.
In Luxembourg, we apply the European regulations just as they are – principally the SFDR [Sustainable Finance Disclosure Regulation] and the EU green taxonomy. There is no additional law in Luxembourg that would infringe or go beyond the European framework, there is no gold-plating. Luxembourg’s financial regulator, the CSSF, made it clear in August 2021 that it would not create any additional national requirements.
Greenwashing carries a great legal and reputational risk for fund managers. The EU’s SFDR framework covers a broad array of financial products and is meant to minimise these risks.
The European Commission knows that some of the key concepts within the regulations are yet to be clarified or understood, and we also know that the Commission and EU financial market regulator Esma [the European Securities and Markets Authority] have made it clear that the categorisation of financial products as Article 8 or Article 9 was never meant to operate as a labelling system for financial products, which is an issue for the industry.
Micaela Forelli, M&G Investments – The pivotal point recently in terms of norms and rules towards avoiding greenwashing and fighting was – of course – the SFDR Level 2 measures. But there is also the so-called ‘green MiFID’ [Markets in Financial Instruments Directive] that was live in August of last year, and obviously the EU taxonomy. Those are three axes or norms that aim for a clearer set of regulations regarding sustainable investing, benefiting the marketplace and end investors.
“The seal of the non-governmental body LuxFlag contributes towards mitigating greenwashing risks. It has drawn a comparison between greenwashing and anti-money laundering, suggesting regulatory intervention over greenwashing will evolve in a similar way to AML.”
SFDR Level 2 has created some debate in the industry and also some concerns, but I think it has been a really positive exercise. It shows that regulation is becoming clearer and clearer. Level 2 in particular triggered a deeper reflection on whether funds were fit for each category, making it easier for clients to understand the sustainability characteristics of the products they’re investing in. That said, SFDR articles are not meant to be fund labels, and part of the debate in the industry revolted around misunderstanding those as such.
When I look at it from a practitioner’s point of view, first and foremost in our experience is that data and technology are key to all of this. To manage greenwashing risk, data must improve in order to help asset managers with the practical implementation and the operationalisation of SFDR rules. Very positively, at the end of last year, the European Council gave the green light to the Corporate Sustainability Reporting Directive (CSRD). This will yield more information and more data, which is good, as at the end of this process, we will likely see four times the number of companies having to disclose non-financial information than at present, and this will be helpful for asset managers to classify investments more precisely.
There are around 11,000 companies that today report non-financial information. This could be 49,000 in 2024 when the CSRD takes hold.
Mattia Scabeni, Generali Investments – Luxembourg leads the way when it comes to ESG [environmental, social and governance] investing, with governmental bodies spearheading initiatives, including the Sustainable Finance Agenda that led to the foundation of the Luxembourg Sustainable Finance Initiative. This initiative intends to guide the financial sector towards sustainability – which includes fighting deceitful behaviours, such as greenwashing.
Greenwashing is a new typology of risk that’s increased in amplitude since the new sustainability regulatory framework started. The framework is a set of tools – like offsite and onsite inspections – to deter financial institutions from intentionally exaggerating the claims of their products’ environmental and sustainability factors.
The seal of the non-governmental body LuxFlag contributes towards mitigating greenwashing risks. It has drawn a comparison between greenwashing and AML [anti-money laundering], suggesting regulatory intervention over greenwashing will evolve in a similar way to AML in the near future, and a recent study demonstrated that both management companies and funds are increasingly paying close attention to the issue and increasing their knowledge and expertise on ESG-related matters.
So, on top of existing EU initiatives, there is also in Luxembourg tight cooperation between the government, the regulator and the financial industry itself that will overcome greenwashing risks in the foreseeable future.
Mathieu Maurier, SGSS – Luxembourg is doing a great deal in relation to managing the strong reputational risks that investment managers face from the potential mis-selling of products. Luxembourg has not needed to gold-plate the EU regulations. The EU has led this issue globally and has done so much towards creating a sustainable finance framework that any divergence by member states could trigger a lot of unnecessary confusion.
But the journey is a long one, and it could take years before all the regulatory complexity is settled. In the meantime, we need to be very careful not to blame financial players but to encourage them along in the right direction. With the reclassification of Article 9 funds to Article 8, the most important element is transparency about what funds invest in. Although the industry must not excuse some misconceptions or misfunctioning that do understandably exist, at the same time, we must be careful not to create an industry that is hampered in its ability to manoeuvre into a better position of risk management.
Forelli – The shift from Article 9 to Article 8 was, in a sense, a necessary technical adjustment. Prior to this, it was not completely clear what investments were acceptable for Article 9 status, leading to some interpretations that were wider than others. A ‘do no significant harm’ test is now in operation, which has led to reflection among firms – for example, about how ‘brown’ assets could be included in funds if they were transitioning to ‘light green’ and eventually to ‘dark green’.
There were also passive funds in Article 9 – yet passive funds have almost no choice in what they invest in.
Bechet – The largest portion of these funds that were affected were index-trackers that track Paris-aligned or climate-transition benchmarks. Yet some of the indices did not align on this requirement. Tracking a climate-transition benchmark does not automatically qualify a fund as Article 9. This was an issue discovered over the course of 2022 and is now a question the European supervisory authorities are asking the European Commission – whether a fund tracking a Paris-aligned benchmark would automatically qualify for Article 9.
Alfi believes that the main characteristics of greenwashing should be intent. The lack of reliable data, and the existence of different interpretations of the sustainable framework, mean there should be vigilance about intentional greenwashing.
Among three developments from European policymakers are the European supervisory authorities (ESAs) issuing a call for evidence to reach a better understanding of greenwashing. Also, Esma is consulting on fund names, focusing on any fund using ‘sustainability’, ‘sustainable’, ‘ESG’ or something similar in its name. Alfi would suggest that instead of only focusing on hard limits about what a sustainable fund can invest in, the guidelines should focus on transparency of both data and investment processes.
The third development to watch is a Q&A from the European Commission in the first quarter of 2023, while more in the mid-term, there will be a comprehensive assessment of the implementation of SFDR and the Taxonomy Regulation.
Funds Europe – In December, Esma published its peer review report on national competent authorities’ (NCAs) handling of firms’ relocations to the EU in the context of Brexit. The publication considered that some regulators were not meeting expectations with regards to delegation. What must the industry do to correct this?
Maurier – Luxembourg was not singled out in this peer review compared to some other domiciles. If there are any gaps in delegation and the monitoring of ‘white label’ servicing activities – which is what the review is about – Luxembourg would be keen to put them right. Substance must apply, that’s for sure, and ‘Letterbox’ organisations are gone from Luxembourg.
Forelli – When M&G expanded its operations in Luxembourg, we already had 30 people here, and now we are more than double that. In part, this is because we needed to make sure that we could properly oversee activities that are delegated back to the UK, such as portfolio management.
The increased substance requirements that followed Brexit were never a surprise for us. A cross-border domicile may carry more potential risk of substance gaps. Any clarity on governance requirements, outsourcing requirements, and the independence of the control functions from Esma and any recommendations are always welcome. But the CSSF was very clear about what was wanted, and substance was at the top of the requirements list when we started. That was and still is very clear.
Bechet – Alfi supports the efforts of Esma and the NCAs to promote wider convergence regarding authorisations and supervisions of investment managers, which is the object of the peer review. The peer review is not making any recommendations to the industry; it is targeting NCAs and how applications were reviewed.
“Alfi believes that the main characteristics of greenwashing should be intent. The lack of reliable data, and the existence of different interpretations of the sustainable framework, mean there should be vigilance about intentional greenwashing.”
The Luxembourg fund industry is critical to the country, and it is the largest contributor to GDP. We are held to the most prescriptive standards, which in fact, are embedded in the Ucits Directive and the AIFMD [Alternative Investment Fund Managers Directive]. We will not diverge from them. A CSSF circular on authorisation and organisation of investment fund managers, which Micaela just referred to, was one of the heaviest and longest circulars ever issued by the CSSF. So, that gives you an indication of how sophisticated the industry and the regulator are in Luxembourg in this respect.
Scabeni – Brexit was an unprecedented, extreme political event, and despite the uncertainty and the complexity, Esma and NCAs – including the CSSF – did good work in facilitating a smooth transition, ensuring stable markets and ensuring the protection of investors.
Management companies like ours, and other regulated firms like custodians and depositary banks, should make a thorough analysis of how the governance framework was set up a couple of years ago when the UK formally left the EU in 2020, with a focus on key departments such as investment management and control functions and flag any misalignments.
Another improvement could be in the exchange of data between EU-based companies and delegated UK partners. I imagine regulators will likely further develop tools – such as ad-hoc reporting by management companies – to indirectly yet effectively monitor any repatriated activities.
I can envisage work will be conducted at the national level to address any possible additional requirements coming from our NCA and quickly implement them, including by putting additional agreements in place with UK partners.
Funds Europe – In light of the recent Esma consultation on the cross-border marketing of Ucits and AIFs, does this panel think that a regulatory convergence between these funds – which would reduce operational costs for fund managers – could ever be achieved?
Scabeni – In general, I see that the convergence of the AIF and Ucits worlds is here to stay and could result in a sharing of good practices and regulatory requirements that will protect investors. For instance, the liquidity management tools proposed recently by the European Commission could be seen as a unifying factor. Neither the existing AIFM Directive nor the Ucits Directive provide for a harmonised set of liquidity management tools.
Achieving a common goal of investor protection is the driver for greater harmonisation, including in light of the so-called democratisation of alternative assets. This shows that harmonisation of regulation can bring new opportunities for the funds industry.
However, it may come at a cost. New requirements will create an additional burden, meaning a reduction in costs for fund managers might only be partially achievable.
Maurier – This democratisation is precisely what we are seeing today. It’s a move to distribute private capital funds or other alternative investments to not only high-net-worth individuals but also to other individuals. This may not be appropriate to ‘retail’ clients right now, but we are approaching a tipping point where investment funds with lower liquidity are distributed to a wider set of individuals. Already there have been some firms lowering the minimum investment amounts, which makes these assets more attainable for more people.
The Eltif II, which came into play recently, is a good example of hybridisation.
However, this triggers challenges for asset servicing providers where, until now, providers have essentially been large Ucits ‘factories’, able to deliver servicing to triple-digit billion-euro investment firms using automation to process NAV [net asset value] calculations around the globe, 24/7.
There has been additional capacity developed to service alternative investment managers who do not need daily NAVs, but perhaps every quarter or semester, and only for very few institutional investors in these funds. Accelerating the frequency of NAV calculation and managing the associated democratisation, hence a significant increase of the investors base on the liability side of the funds, for less liquid assets, are something we are working on.
Forelli – More commonality in passporting arrangements across national borders would increase funds activity, but it is important that any harmonisation between Ucits and AIFMD does not lead to a set of minimum standards. Standards must not be lowered.
“We are approaching a tipping point where investment funds with lower liquidity are distributed to a wider set of individuals. Already there have been some firms lowering the minimum investment amounts, which makes these assets more attainable for more people.”
For example, concepts like expected duration for a fund, or a maximum capital-raising target, don’t apply when speaking about harmonising Ucits funds with AIFs because Ucits are open-ended funds – albeit many AIFs are, too. So, although more harmonisation and simplification is always welcome, we must avoid making everything a one-size-fits-all solution.
Something we deeply care about again here is technology and operational efficiencies. The question is about how to operationalise these things. In my view, if we had a European-wide platform for passport notifications, that would be an improvement. Having passport notification in one place and notification for relevant NCAs would clearly simplify the notification process.
Bechet – A requirement for Ucits to give the duration of a fund would not be relevant because, as was said, Ucits are open-ended. Esma did take note of this and, clearly, adopting a one-size-fits-all approach for Ucits and AIFs would not work in all situations. Ucits and AIFMD are entirely different directives – Ucits is a product regulation, the AIFMD is a managers’ regulation. It would not be easy to reconcile the two.
Esma published the consultation on May 17, 2022, and it was about the proposed draft regulatory technical standards (RTS) and implementing technical standards (ITS). The public consultation closed on September 9. Alfi responded to the consultation, but there were, in fact, few responses to this consultation.
The final report further to this consultation was issued at the end of December, and the RTS and ITS have been submitted to the EC for adoption within three months, respectively, in the form of a Commission-delegated regulation and a Commission-implementing regulation. Following their adoption, these will then be subject to the non-objection of the European Parliament and of the Council.
Generally, there is a need for a balanced approach. Alfi understands and appreciates Esma’s intention to achieve alignment between Ucits and AIF documentation because this usually facilitates both filings and checks by regulators. However, for certain aspects, one could question if these draft technical standards go beyond the existing practices and requirements of the Ucits Directive and AIFMD – for example, the information on delegation arrangements that was specified in Article 3 of the draft RTS.
Funds Europe – Finally, what are two or three regulatory trends of importance to asset managers that will gain increasing traction over the next year or two?
Forelli – I would point to the Eltif review, because it could devise a regime which facilitates retail investments in private markets, bringing a lot of opportunities to investors. The Commission’s impulse to change the Eltif structure has progressed very positively and considerations have been given to better scoping, which are the eligible assets, allowing wider geographical reach, improving the definition of real assets and lowering the minimum investment levels and concentration limits to make the product more accessible. These considerations will hopefully ensure that more investments are channelled to long-term investment projects and also offering better investment solutions to a wider number of clients. The aim is to make Eltifs the ‘go-to’ fund vehicle for long-term investment across both retail and professional investors, increasing diversification in clients’ portfolios and making some asset classes, and their benefits, more accessible to retail investors.
Scabeni – In general, a principal challenge for asset managers will be to keep up to date with responding to regulatory proposals so as to avoid the risk that regulations diverge in areas such as ESG.
But I would also draw attention to how assets are valued. There have been some regulatory initiatives around this in response to the Russia/Ukraine crisis, which did lead to market valuation issues, primarily in Ucits funds, even though Ucits are already heavily regulated. And beyond Ucits funds, there are similar issues with alternative funds – which includes Eltif version 2.0. There is more and more attention on the valuation process performed by management companies and AIFMs.
Private equity, private debt, and infrastructure valuations are more nuanced than publicly listed securities. The pricing of alternative assets is not driven by regulatory guidelines. Often, the assessment of assets and the appropriateness of the valuation is left to a fund’s auditor, which leads to a dichotomy in cost versus fair value and valuation frequency.
These are barely scrutinised today, but they will be under the spotlight of the regulator.
“The Commission’s impulse to change the Eltif structure has progressed very positively and considerations have been given to better scoping which are the eligible assets, and lowering the minimum investment levels and concentration limits to make the product more accessible.”
Maurier – The Eltif is important, but I will highlight again ESG and similar thematic investment. We have covered this at length, but in particular, the Corporate Sustainability Reporting Directive and all the initiatives to cover the corporate disclosures (with, for instance, the ISSB initiatives) are important to watch. There will be new accounting standards and reporting standards in the coming years.
Bechet – I agree these topics are top of the regulatory agenda. But again, I’d highlight sustainable finance. This is a huge, huge agenda, and I think we are only halfway there.
For example, within the taxonomy regulation, there is a question on methodology – the way that sustainable activities of companies are accounted for when calculating the percentage of taxonomy-aligned assets. There are two approaches: a revenue-weighted approach or a pass-fail approach.
And where there are already technical screening criteria in place for two objectives of the taxonomy, four more are to come – for water, the circular economy, pollution prevention and for biodiversity.
There will also be an EC delegated act and draft templates for gas and nuclear-related activities that comply with the taxonomy. This is not a popular subject.
These are only some of the developments coming up. What will be needed from all of us in the asset management world will be new technologies and new competencies because sustainable finance really is a game-changer that will stay with us for some years to come.
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