Sustainable investing and its impact on the Fund Industry
Sustainability is hardly a new concept in our lives. Indeed, it has been gaining momentum for some years now. However, we have been recently witnessing an acceleration to all sustainable/ESG-related matters, including the increasingly greater shift towards sustainable investment choices. In this article, we are elaborating on relevant key terms and also looking into the impact of sustainability/ESG on the funds sector.
Understanding the terminology
To begin with, it is important to understand the relevant terminology used when discussing the topic of ESG.
Accordingly, ESG refers to three key standards that measure the sustainability impact of a company’s policies. E stands for Environmental (examining what is the impact of a company’s actions and policy on the environment and climate change), S for Social (examining, for example, what is a company’s stance on racial discrimination or LGBTQ+ matters etc.) and G for Governance (for example, how is leadership interacting with the shareholders or what is the company’s position on diversity in the boardroom). Thus, when investors adopt an ESG investment strategy, it simply means that their focus is on investing in businesses and companies that actively and transparently apply these criteria, with the ultimate goal being to promote positive change through their investment choices. That could also be described as “sustainable finance”, a notion that is understood to refer to sustainable, long-term economic growth.
A great cause of concern is undoubtedly “greenwashing”. According to the EU Taxonomy Regulation, “greenwashing refers to the practice of gaining an unfair competitive advantage by marketing a financial product as environmentally friendly, when in fact basic environmental standards have not been met”. In essence, it is a deceitful practice adopted by a company to convey the misleading message to the public that it is a socially and environmentally responsible entity, for the purposes of gaining considerable profits. Several examples of greenwashing have emerged throughout the years, as companies try to profit from investors’ heightened interest into ESG. As a result of this, the Taxonomy Regulation has introduced criteria determining whether an economic activity is environmentally sustainable for the purposes of establishing the degree of environmental sustainability of an investment.
According to Article 3 of the Taxonomy Regulation, an economic activity shall qualify as environmentally sustainable where that economic activity:
contributes substantially to one or more of the environmental objectives (as these are set out in the Taxonomy Regulation);
(b) does not significantly harm any of these environmental objectives;
(c) is carried out in compliance with the minimum safeguards. These safeguards shall be procedures implemented by an undertaking that is carrying out an economic activity to ensure the alignment with the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights; and
(d) complies with technical screening criteria that have been established by the EU Commission.
The impact of ESG on the regulation of the Funds
Focusing on the funds industry, it is worth exploring the impact that ESG has and will increasingly have on the collective investment schemes. In accordance with the Commission Delegated Regulation (EU) 2021/1255 and Delegated Directive (EU) 2021/1270, all authorised fund managers are required to ensure that they integrate sustainability risks in their portfolio and risk management processes and overall governance structure from the 1st of August 2022. ESMA has explicitly stated that this is applicable to both fund managers that offer sustainable funds, and to those that do not.
Furthermore, it is expected that the EU National Competent Authorities should verify compliance of AIFMs and UCITs Management Companies with these rules by taking the following actions:
- Checking the description of the manner in which sustainability risks are integrated in their investment decisions in pre-contractual fund disclosures;
- Ensuring that AIFMs and UCITs Management Companies perform a review of the relevant internal policies and procedures on a periodic basis;
- Performing sample checks on surveys and questionnaires on the disclosures of sustainability risk integration on websites.
It is important to highlight that under the EU Sustainable Finance Disclosure Regulation (“SFDR”), the EU regulators are granted the necessary supervisory and investigatory powers to exercise their monitoring functions in relation to the ESG requirements. It is thus envisaged that administrative measures may be used in cases of greenwashing. ESMA, in its Supervisory briefing, provides a non-exhaustive list of examples of cases that regulatory action could be taken. This includes cases of when legally required SFDR disclosures have not been made at all after the application of the new rules or where sustainability risks have not been integrated throughout the organisation.
It is undeniable that ESG investing is here to stay. More and more investors choose investments that will ensure a positive, ethical impact on the environment and the society we are living in. The sooner businesses understand the consequences and the great opportunities that can be potentially derived from this remarkable shift in investment choices, the more appropriately they will respond to it and become part of it. In relation to the funds sector, it is unquestionable that fund managers have an immense task ahead of them that requires thorough planning, adequate expertise and resources to be able to ride the ESG wave.
 COMMISSION DELEGATED REGULATION (EU) 2021/1255 of 21 April 2021 amending Delegated Regulation (EU) No 231/2013 as regards the sustainability risks and sustainability factors to be taken into account by Alternative Investment Fund Managers.
 COMMISSION DELEGATED DIRECTIVE (EU) 2021/1270 of 21 April 2021 amending Directive 2010/43/EU as regards the sustainability risks and sustainability factors to be taken into account for Undertakings for Collective Investment in Transferable Securities (UCITS).
 European Securities and Markets Authority, Supervisory briefing on Sustainability risks and disclosures in the area of investment management, ESMA34-45-1427 of the 31ST of May 2022.
 As per above.
 Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability‐related disclosures in the financial services sector.
 As per footnote 4.
 Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088.