Author: Dorothy Murray
The rise of Environmental, Social and Governance (ESG) matters in societal, corporate and regulatory importance creates particular issues for asset managers, who find themselves at a peculiar cross section of data risks, pro-ESG investor sentiment, and anti-ESG investor sentiment, with detailed regulation on one hand and a lack of standardization in international regulation on the other. This blog post explores how asset managers can navigate these trends.
Asset managers that operate across borders, for example in the investors they market to, must comply with all applicable regulations. As explained below, these regimes are not yet fixed and so must be kept under regular review.
In the EU, the Sustainable Finance Disclosure Regulation (the SFDR) has applied since March 2021, with the Taxonomy Regulation applying on a phased basis since 1 January 2022. Both these regulations apply to “financial market participants”, which includes EU MiFID investment firms that provide portfolio management, UCITS1 (or their EU management companies), and alternative investment fund managers (AIFMs) as well as non-EU AIFMs that have marketed one or more of their funds in the EU. The combined effect of the Regulations is to require in-scope firms to:
- categorise their investments funds according whether they have an environmental or sustainability objective (so-called “dark green”), promote environmental or social characteristics (“light green”) or neither (“grey”)
- make certain specific disclosures in offering and promotional materials
- comply with certain defined screening criteria and reporting requirements for qualifying investments.
The UK’s Financial Conduct Authority (FCA) recently closed its own consultation on the UK’s development of its own ESG disclosure regime, with final rules now expected to be published by the end of 2023in Q3 of 2023. That consultation focused on UK authorised asset managers, but it is not yet clear whether overseas products marketed in the UK will be subject to the new regime. The rules are expected to include equivalent provisions to the EU regime requiring accurate labelling of financial products claiming to be sustainable, as well as consumer and institutional investor facing disclosure requirements. The FCA has indicated that it will seek coherence with other international systems and is therefore likely to align with the EU regime.
There is, as yet, no equivalent federal level ESG regime in the US. Rule proposals are expected from the US’s Securities and Exchange Commission (SEC) that will codify disclosure obligations regarding ESG activities and facilitate oversight by SEC staff of ESG claims. Where exactly the SEC will come out in terms of the energy transition and climate change aspects of ESG is harder to predict, given the “anti-ESG” approach adopted by some US states.
The examination priorities for 2023 recently published by the SEC’s Division of Examinations reiterated the SEC’s long held concerns to ensure that advisers are employing the ESG strategies they are marketing to investors, to prevent so-called “greenwashing”. The SEC’s 2022 enforcement results showed again this focus on statements and omissions, with the SEC taking enforcement action against advisers and companies who were considered to have made materially misleading statements and/or omissions in disclosures about their use ofthe incorporation of ESG principles factors in their investment process as in the case of BNY Mellon Investment Adviser, Inc., or about the ESG impact of their underlying business operations as in the case of Vale SA, following the collapse of the Brumadinho dam in Brazil.
Regardless of regulation, however, investors make their own requests from asset managers for ESG data about funds themselves and their portfolio companies. This is to meet investors’ own reporting requirements, to meet their contractual obligations to their stakeholders and to allow assessments about the impact and effectiveness of ESG investing.
In the absence of applicable regulation in every jurisdiction, asset managers typically negotiate these data provisions on a case-by-case basis, including by way of contractual obligations in side letters. With the proliferation of available information in our electronic age, identifying meaningful relevant data that is not too costly or burdensome to collate is a constant challenge as each Limited Partner (LP) may require a different set of KPIs and performance assessment frameworks.
To address this challenge, the private equity industry itself is seeking to create a standard set of metrics and KPIs, for example in the ESG data convergence project, a partnership of stakeholders including General Partners (GPs) and LPs which focuses on 15 agreed core metrics. These include greenhouse gas emissions, C-suit diversity and employee engagement. It remains to be seen whether regulators across the globe adopt a similarly standardized approach.
To summarise:
- Check all applicable regulation to the product or investment in question
- Say what you do, do what you say
- Be wary of over-promising in terms of ESG data reporting
- Understand what data is needed by LPs and why to ensure their needs are met efficiently, without creating hostages to fortune and risking future contractual breaches.
Dorothy Murray
Dorothy Murray is a partner at Proskauer Rose in London specializing in investment and commercial dispute resolution, in the courts and in arbitration. She supports clients across a wide range of sectors, including financial services, asset management/private equity, energy and telecoms. Dorothy represents clients in disputes arising from all aspects of their business, and at every stage of the company or investment’s lifecycle. She is a co-chair of the firm’s Asset Management Litigation group.