Nobody ever said putting in place sustainability disclosure rules for funds was going to be easy, and it has been anything but.
The European Commission’s responses in April to a small number of questions posed last year by the European Supervisory Authorities (ESAs) on the SFDR showed that the industry’s reaction to an earlier “clarification” by the Commission may have been premature and has led to massive disruption.
We all remember the “great reclassification” of funds last year, when around 40% of the assets in Article 9 funds were downgraded to Article 8 after the Commission confirmed that the former must only hold sustainable investments. Many of the funds that were reclassified were ETFs and funds tracking Paris-aligned benchmarks (PAB) or Climate Transition benchmarks (CTB), because they couldn’t be certain that all the underlying assets were sustainable.
A large part of the problem came down to the need to position funds correctly ahead of the introduction of the Level 2 disclosure rules and templates at the start of this year.
Then last month (a while after those disclosure rules took effect), the Commission told the ESAs that products tracking a PAB or a CTB are automatically deemed to make sustainable investments. So all those groups that decided to populate the Article 8 disclosure templates instead and changed their fund prospectuses to reflect their new Article 8 status should now reverse that decision and go back to disclosures under Article 9.
Let’s not forget that Articles 8 and 9 are not fund labels that groups can choose whether or not to adopt. The SFDR says that if a fund “has sustainable investment as its objective” (and only makes sustainable investments), it needs to make the pre-contractual disclosures set out in Article 9, using the appropriate template, and then include this disclosure in the fund prospectus.
Considering the rush to reclassify Article 9 funds as Article 8 last year, it is ironic that another of the Commission’s answers warns of the possibility that some Article 8 funds may, in fact, run the risk of straying into Article 9 territory.
If a product promotes carbon emissions reduction as an environmental characteristic (Article 8), it must ensure that its marketing and regulatory disclosures “should not mislead investors into thinking that this aspect is part of the product’s objective”, which would mean that the fund should, after all, make Article 9 disclosures.
However helpful the latest clarifications from the Commission may have been, I could imagine the sustainability teams at some asset management groups with their heads in their hands in despair.
How would apparent flip-flopping between Article 8 and Article 9 disclosures (even if it is because the guidance changes) help to build investor confidence in the industry’s ability to manage sustainable funds? And how would an investor feel if they had switched out of a fund tracking a Paris-aligned benchmark because they learned that it no longer satisfied their requirement for an Article 9 fund?
I would be very surprised if any group were in a hurry to change the disclosures of its funds again until there is something approaching stability, particularly given that, only two days before the Commission published its Q&As, the ESAs issued a 158-page consultation paper on a review of the SFDR Level 2 product and principal adverse impact disclosures, with 43 more questions.
With four new mandatory social PAIs – earnings from non-cooperative tax jurisdictions, exposure to tobacco companies, interference in the formation of trade unions, and employees earning less than the adequate wage – and the third iteration of the four disclosure templates less than four months into the disclosure regime, it would take a brave person to leap back into the fray so soon.
In the UK, the Financial Conduct Authority (FCA) has delayed the publication of its policy statement on sustainability disclosure requirements and investment labelling by up to three months because it received over 240 responses to its consultation. The UK’s green taxonomy had originally been expected by the end of last year, but we have now been told there will be a consultation on it by the end of this year.
I applaud these delays if it means that what is eventually delivered will be clear, fair and not misleading to both the industry and investors, and left alone for a reasonable time. Of course the FCA is under pressure to get something out sooner rather than later, but you only need to look across the Channel to see what happens if these things are rushed. Despite the European Commission having delayed the implementation of the Level 2 rules for SFDR, after going ahead with the primary regulation, it is still grappling with controversial changes to the taxonomy and multiple versions of the disclosure templates.