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Magazine Issues » September 2020

Legal Ease: Fifty shades of green

Martin_Mager“Do we need risk disclosure because there are ESG criteria in the fund’s investment strategy?” – “No, you need risk disclosure if there are not.”

This is the short version of a discussion I followed recently between the legal counsel and a portfolio manager with respect to the infrastructure fund that they are establishing.

In a way, it sums up the shift in perception and relevance of ESG. As studies suggest, sustainable investments are generally not less profitable than others. Sustainability is one of the current megatrends in the world of investment funds.

Financial market participants in Europe work with high pressure on the implementation of the EU Disclosure Regulation coming into force in March 2021. They will need to disclose to what extent ESG criteria are being incorporated into their services and products. There is, however, still a great need for clarification. Under which circumstances does a product “promote” environmental and social characteristics? Are investment funds in scope even if they are no longer marketed? There is not much time left for implementation and keeping eyes closed is simply not an option.

Disclosure is good and necessary, but it does not guarantee that there will be a large universe of truly sustainable, dark green or social products available. When products are labelled green today, the shades may vary significantly. And despite there being a lot of talk about green products in many areas (e.g. “green bonds”), it seems there is still a lot of untapped potential for investment funds with a strong focus on sustainability. Many investors are subject to ESG requirements and are looking for truly sustainable financial products (including investment funds) as a matter of priority.

In my view the EU Taxonomy Regulation may make a real difference, as it is designed to provide a uniform classification system for sustainable economic activities. The label “taxonomy-compliant” can indeed prove to be a great marketing instrument for investment funds.

For many funds, it is easy to show that they contribute substantially and measurably to one of the environmental objectives as defined in the EU Taxonomy Regulation.

Slightly more difficult are the other requirements, i.e. not significantly harming other environmental objectives and compliance with the minimum safeguards and the technical screening criteria. It remains to be seen whether those requirements will in the coming months be specified in a way that they can actually be fulfilled by fund managers.

When talking about sustainable investment funds, retail investors should not be forgotten. There is of course the more general discussion about how to make alternative investments more accessible for retail investors. With respect to sustainable investment funds, there may be more specific answers. The Eltif Regulation already provides a framework for infrastructure funds to be marketed under the EU passporting regime to retail investors. Even in Luxembourg, where many Eltifs have been set-up, however, there are still a lot of interpretation queries and certain rules are still too restrictive, both with respect to marketing and investment restrictions. Amending these rules at European level could make a – very green – difference!

Martin Mager, partner at Linklaters Luxembourg

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