The industry accepts the need for more rigour to ESG fund reporting. But the work will be pointless if investors don’t understand the end result. Nicholas Pratt reports.
The EU’s sustainability disclosure rules are too complex and risk overwhelming consumers with too much information they do not understand. This was one of the points made during a Funds Europe webinar on sustainability reporting entitled ‘Conquering the ESG data and reporting challenge’.
Fund managers face a wave of regulatory and non-regulatory reporting requirements over the next two years and beyond. 2021 saw the introduction of the EU’s Sustainable Finance Disclosure Regulation (SFDR).
As of June 30, 2021, companies with over 500 employees had to report their adverse sustainability impact disclosures. And then on January 1st, the periodic product disclosures for article 8 and 9 funds came into force.
But investment firms in Europe also face sustainability reporting requirements for MiFID II, the Insurance Distribution Directive and, in some cases, the UK’s Sustainability Disclosure Requirements (SDR) regime. Added to this are other sustainability-related initiatives such as the Taskforce on Climate-related Financial Disclosure.
While the industry welcomes the introduction of more disclosure around sustainability, there is also concern about just how complex the initial implementation of these rules will prove to be. As Clive Emery, fund manager at Invesco EMEA said: “The direction of travel is excellent but the journey is like being stuck in a traffic jam on the M25.”
He described the current situation as a “complex quagmire with competing regulations both nationally and internationally with different sectors and different market participants”.
One of the problems with the SFDR is that it has only been partially implemented. It went live in March 2021 but without the regulatory technical standards (RTS), or level 2 requirements, needed to complete the reporting. These standards are expected to be endorsed some time in the year’s first quarter.
According to Mikkel Bates, regulatory manager, FE fundinfo, the staggered implementation is partly a result of the complexity of the standards and partly a result of political pressure to ensure the regulation was not delayed any further. “Anything that seemed to be pushing back on sustainability disclosures would have been unacceptable for European regulators,” said Bates.
However, the delay to the RTS has been welcomed by some in that it gives them more time to prepare for the full reporting requirements. In addition, the European Securities and Markets Authority (Esma) is hoping to provide more guidance on some of the more technical aspects, such as the calculation of specific principle adverse impacts.
According to Sebastian Brinkmann, ESG Strategic Sales Specialist, FE fundinfo, the incomplete status of the SFDR has created a labelling regime where firms have registered their funds in line with the EU’s categories – articles 6, 8 and 9 - but without the detail needed to explain what those categories mean.
“On the one side, the EU will be content with the number of funds that have registered as sustainable,” said Brinkmann. “But the degree to which they can prove that sustainability and provide the necessary data will be a huge regulatory risk for a lot of firms.”
A further complexity for UK funds is that the SDR is likely to diverge from the EU. However, the UK’s Financial Conduct Authority’s more principles-based approach was favoured by the panellists in comparison to Esma’s rules-based stance with the SFDR.
Emery cited the FCA’s talk of a transparency toolkit to help investors navigate the ESG market as opposed to Esma’s “policy approach to shift capital”. “We have to understand that this is a consumer-facing business and we have to make it simple,” said Emery.
Bates highlighted the FCA’s use of the phrase “decision-useful disclosures” as a means to help consumers make their decisions about sustainable investment.
From a data management perspective, firms will also have to ensure that they think about their ESG reporting in a broader framework, said Brinkmann and to think of simplified ways of communicating key ESG characteristics and performance metrics to investors.
But that data will have to be very closely aligned to the regulatory reporting. “You can’t have ESG data on a fact sheet that doesn’t match ESG data in an SFDR disclosure,” said Brinkmann. “That doesn’t come without risk because there is more oversight.”
Lack of data standards
Another challenge facing the industry is the lack of standardised data around ESG, said Thomas Harding, head of ESG regulatory solutions, ISS ESG. While there are certain initiatives such as the European ESG template and the European Single Access Point designed to bring more harmony to the reporting process, Harding stated that the initial cost burden on ESG data vendors and market participants will be significant.
“Ultimately more data is a good thing as long as it is reliable but it is inevitable that it will come in different formats, especially during these early stages,” said Harding.
The panel also highlighted an additional challenge - the subjectivity that comes with sustainability. As Harding said: “The biggest challenge is defining what exactly a sustainable fund is in the eyes of the regulators and then to quantify the portion of your fund, product or portfolio that meets those criteria. There are different approaches set out by regulators but ultimately the definition of sustainability is subjective.”
For service providers, it is about educating the market as to how they can take a data-driven approach to this problem and also explaining that there is an element of choice here, said Harding.
For Emery, it makes more sense to have the market decide rather than having the regulator define sustainability by line item. “You have to let funds determine their own sustainability criteria and then let the market agree with it. But then regulate it to ensure that funds are delivering what they say they will.”
Despite the daunting challenges facing firms, there was also some optimism expressed by the panellists including the prospect of more interoperability around sustainable finance, an increase in the provision of more high-quality sustainability data from corporates, the development of a more consumer-friendly labelling regime and recognition of a fundamental shift in the industry’s embrace of sustainability.
As Emery concluded: “Clients are demanding that we are stewards of their capital and not just valuers of equity. It is a fundamental shift and will take many years to develop but I can only see the acceleration of this heading in the direction we all want it to go.”
*To watch the 'Conquering the ESG Data and Reporting Challenge' webinar, visit our Webinars Channel.
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