Financiers and regulators are taking big steps in the development of responsible investment as a mainstream feature of the funds industry with lessons from the pandemic offering renewed impetus.
Activity in the European Union around environmental, social, and governance (ESG) has not been confined to governmental and regulatory bodies in recent months – and has been a focus for the funds industry too. The Association of Real Estate Funds, or AREF, the Alternative Investment Management Association (AIMA) and the British Private Equity & Venture Capital Association (BVCA) are industry bodies that are taking the lead in discussions around ESG and responsible investment.
As the industry engages increasingly with sustainable investing, much of the development in Europe is aimed at AIFs (alternative investment funds) and UCITS (undertakings for collective investment in transferable securities). But can the current momentum behind sustainable finance mark a permanent change in investment practices and behaviours?
In December 2019, the European Commission adopted the European Green Deal, which significantly increases the EU's climate change action and environmental policy ambitions. The European Green Deal subsequently announced a Renewed Sustainable Finance Strategy to build on the ten actions put forward in the EU's Action Plan for Financing Sustainable Growth. On 8 April 2020, the European Commission launched a consultation process to collect the views and opinions of interested parties in order to inform the development of the Renewed Sustainable Finance Strategy. The consultation closed on 15 July 2020.
In April 2020, ESMA issued a joint consultation with the other European Supervisory Authorities (ESAs) on the proposed Regulatory Technical Standards (RTS) on content, methodologies and presentation of disclosures under the Sustainable Finance Disclosure Regulation (Regulation (EU) 2019/2088).
The consultation closes on 1 September 2020. (We commented on the Disclosure Regulation in our previous Insight and will provide a more detailed update when the RTS is published, which is expected later this year).
At the beginning of June, as part of the Renewed Sustainable Finance Strategy, the European Commission published six draft delegated acts for consultation aimed at AIFs, UCITS, investment firms, insurers and insurance distributors.
The European Commission refers to "sustainable finance" as the process of taking due account of environmental and social considerations when making investment decisions, leading to increased investment in longer-term and sustainable activities. All three components – environmental, social and governance – are integral parts of sustainable economic development and finance.
The draft legislation seeks to clarify the duties of financial institutions to provide their clients with clear advice on the social and environmental risks and opportunities attached to their investments, with three primary objectives in mind:
- To shift capital flows away from activities that have negative social and environmental consequences.
- To better assess and manage financial risks resulting from e.g. climate change and environmental damage.
- To direct finance towards economic activities that have genuine long-term benefits for society.
- Organisational requirements: a requirement for Managers to take into account sustainability risks when complying with the organisational requirements in the UCITS Organisation Directive and AIFMR.
- Due diligence: a requirement for Managers to take account of principal adverse impacts of investment decisions on sustainability factors as part of their investment due diligence.
- Resources and expertise: a requirement for Managers to retain the necessary resources and expertise for the effective integration of sustainability risks.
- Conflicts of interest: a requirement that the identification of conflicts of interest must also include those conflicts of interest that may arise as a result of the integration of sustainability risks.
- Risk management policies: a requirement that risk management policies must also consider the exposures of AIFs or UCITS to sustainability risks.
- Senior management: a requirement that senior management be responsible for the integration of sustainability risks.
- UCITS management: in respect of UCITS, an overarching requirement for investment companies to integrate sustainability risks into the management of UCITS.
The consultation closed on 6 July 2020 and the proposed legislation will start to apply one year after their entry into force (that is, the second half of 2021, assuming they are published this year). Since the Disclosure Regulation and the Taxonomy Regulation are also both due to come into effect during 2021, Managers would be wise to start their preparations for these changes sooner rather than later.
The transition period is scheduled to end on 31 December 2020. Until that point the UK is obliged to transpose EU directives into UK law. However, the implementation deadline for the proposed delegated directive is after the end of the transition period. Similarly, the proposed delegated regulation will not be automatically onshored at the end of the transition period because it will not have become applicable by that date.
The UK Government has indicated in the past that it does not intend to depart from the EU framework, and the growing (global) demand for responsible investment is difficult to ignore. The expectation therefore must be that the UK will seek to align itself with these European standards post-Brexit.
Fad or future?
Responsible investment is spreading globally, and at a rate never seen before. There has been a substantial increase in capital raising for responsible investment projects and, most noticeably, impact investment professionals attribute the upsurge not just to government funding but also to growing private investor capital.
In a webinar hosted by AIMA in May, presenters noted that the ESG movement has been making significant strides within the hedge funds industry. Although the US is still a fair way behind -and the view is that Europe is clearly leading the charge – institutional investors have in recent years been driving demand for ESG investment. This has given fund managers renewed motivation to take a more holistic approach to sustainable investment.
Hedge fund managers acknowledge that the capital markets are still very slow to price sustainability, emphasising that the largest constraint on responsible investment is the quality and consistency of the data currently available. There is a growing consensus in the investment community that the key to unlocking responsible investment lies in the market's ability to measure the impact of investments, both positive and negative, on our society.
Following the coronavirus pandemic, priorities within businesses have shifted, and will continue to shift, with a heightened awareness not just around health and safety in the workplace, but also mental health and wellbeing. In a recent BVCA webinar, commentators highlighted that the "S" in ESG – for "social" – is coming to the forefront of minds as a greater number of general partners and limited partners turn their focus to what would be "the right thing to do"; alongside aiming to maximise exits from investments. Industry leaders believe that with strong leadership from governments on environment and climate change, the private equity and venture capital industries will be well placed to push initiatives forward.
As investors turn their minds to a gradual return from lockdown, those with a focus on ESG – and how money is deployed and its wider social good – may have a competitive edge.
The Wall Street Journal reported recently that funds focusing on socially responsible investment have become a beacon of hope throughout this year's market turmoil. During these challenging times in the wake of a global pandemic, governments, industry bodies, investors and fund managers are seeking a shift in practices and behaviours, with a mutual recognition that each has a role to play in driving positive social and environmental change for the generations to come.
This article is provided as a general informational service and it should not be construed as imparting legal advice on any specific matter.
Anna joined Osborne Clarke as a Senior Knowledge Lawyer within the Financial Institutions Group in March 2018, where she covers 4 core service lines: Funds, Payments, Financial Regulation and Consumer Credit. She has a broad range of experience advising on domestic and cross border insolvency, restructuring and regulatory issues and has particular expertise in assisting investors, creditors, managers and independent directors of distressed funds. She also has commercial litigation experience in relation to fund, shareholder and financial services disputes.
Seema is a Senior Associate in the Financial Institutions Group (FIG) specialising in investment funds. She advises fund managers on the formation and management of open and closed ended investment funds in multiple asset classes, including real estate, venture capital and private equity funds. She also acts for a wide range of investors, including pension funds and other institutional investors as well as family offices and high net worth individuals, in relation to their investment into existing funds and discretionary investment mandates.
For more information, please visit www.osborneclarke.com.