How could the decisions of the past impact the future of your business?
Investors want financial products which are aligned to their Environmental, Social and Governance (ESG) preferences. They want to make investments with asset managers who are transparent about their own ESG strategy and ambitions and who are credible in the market. 10 March 2021 was a significant date – the date by which European financial products had to be classified as being Article 6, Article 8 or Article 9 under the Sustainable Finance Disclosure Regulation (SFDR). Some may have approached this date with caution, not wanting to over commit and under deliver. Are these asset managers now facing pressure from their current and future investors to offer Article 8 or 9 financial products as opposed to Article 6 products?
The Asset and Wealth Management (AWM) landscape changed significantly after 10 March 2021. It saw a shift away from being able to purely mention ‘ESG’ or ‘sustainable’ in the name of a financial product. From this date, under the SFDR, all financial products had to be classified as Article 6 (non-ESG), Article 8 (those which promote an environmental or social characteristic either alone or in combination with other characteristics) or Article 9 (those which have sustainable investments as their investment objective as defined in Article 2(17) of the SFDR
Many asset managers may have approached this date with caution. The level 2 reporting requirements (under the Regulatory Technical Standard or RTS) were not finalised by this date and therefore asset managers may not have wanted to be in a position where they committed to an Article 8 or 9 classification without fully knowing and understanding the associated disclosure requirements. Regulators will likely take a hard line with product providers which are found to be ‘’greenwashing’’. It is not only a reputational risk which product providers face, but also a risk to their capital flows and the potential of finding themselves facing misconduct charges from regulators.
Investors’ demands have evolved and for many, it is no longer only financial return which they seek, but also an alignment to their own individual sustainability or ESG preference. Investors may no longer want to invest in products which are not classified as either Article 8 or 9 financial products.
Whilst financial product classification should not be seen as a “badge”, there is no doubt that the regulations have put increasing pressure on product providers not only in relation to their disclosure obligations, but also in relation to the need to meet investor demands. Will investors with strong ESG preferences be satisfied to continue their investment in Article 6 financial products, or will they seek out investments in only Article 8 or 9 financial products? In “2022 The growth opportunity of the century’’ report, which was issued in 2020, 77% European institutional investors indicated that within 24 months of taking a survey that they would stop purchasing non-ESG European financial products. This could indicate to product providers that there is a real need to revisit their portfolio composition and financial products on offer. Is there a future for Article 6 products?
As European regulations have continued to evolve, it is clear that meeting these new requirements should not be seen as purely a compliance exercise. The decisions which need to be made, should have been made in conjunction with an asset manager’s overall strategic direction. However, for many, due to the associated timeframe within which decisions were needed and the lack of clarity in relation to the associated disclosure obligations, the decisions may have been made as part of a pure compliance exercise. However, it is not too late to change these decisions.
Whilst the next significant date in the European disclosure timeline is 1 January, 2022 between now and then, asset managers need to consider whether their financial products should retain their original classification which was finalised in March, or whether their financial products are in fact more representative of an Article 8 or 9 financial product. As part of this consideration, there is of course the need to identify the additional reporting obligations under SFDR. Areas which will be impacted include pre-contractual, website and annual reporting documents. Consideration will also need to be given to the degree of change which is needed to their own investment procedures, processes and controls, the due diligence process – initial and on-going, the investment objectives of each financial product, internal operating, monitoring and reporting processes and of course the availability of data and its alignment to the internal and external regulatory reporting obligations.
There is no doubt that SFDR continues to have a significant impact on the AWM industry. However, it affords the opportunity for asset managers to align and realign their own strategic direction and financial products, to the demands of their current and future investor base. ESG is more than just a box ticking exercise, it is about creating;
- the opportunity to make a difference;
- sustained outcomes which drive value and fuel growth; and
- strengthening our environment and society.
The six key actions to take now
For those considering whether to change their financial product classification, here are some key considerations and actions to take.
Review your current portfolio of financial products
Consider the financial products which you are offering your investors. Are these meeting the needs and preferences of your current and also potential future investors?
Understand the regulatory requirements associated with each product classification
You may be considering changing the classification of your financial products however, do you understand the implications of this? The different product classifications have varying degrees of disclosure requirements, therefore before you change the classification of your financial products, ensure you understand these.
Revisit the investment objectives of your financial products
It is not only the investment objectives of your financial products which will need to be reviewed. It is also the related investment policies, processes, procedures, controls, due diligence procedures and financial product portfolio composition. Changing from an Article 6 classification to Article 8 or 9 brings with it a significant change in regulatory requirements. Do not undertake this decision without fully reviewing your existing processes and procedures as changes may be needed to these to ensure you can meet the requirements.
Consider the availability of data
There is no doubt that one of the most significant challenges facing the industry is the availability of data. However, it is not only data availability at year end which should be considered, but also the availability of data throughout the year. Consider whether existing data is sufficient to meet the disclosure requirements, or whether new sources will be needed. Revisit your data governance framework as well to ensure that there are appropriate procedures and controls in this area to ensure the credibility and reliability of your data.
Consider whether upskilling is required
Not only with senior management and boards and audit committees, but also within the entity itself and related service providers. As the regulatory landscape changes, take this opportunity to ensure all stakeholders understand these changes and also the impact of the different regulatory requirements associated with each financial product classification.
Don’t forget the other European Regulations
Whilst we have discussed the considerations under SFDR, there are other regulations which may also impact your financial products and require disclosures. Ensure you keep abreast of developments in this area and the related reporting timeline associated with each.
Insights from PwC Ireland