With environmental, social, and governance (ESG) funds on a dramatic incline, an incline expected to continue going forward, it seems inevitable that regulatory reform is on the horizon. Europe has been leading the charge in the incorporation of ESG considerations into its regulatory framework. As we look to gauge what type of regulatory reform might be around the corner in the US, specifically in the realm of fund finance, it is useful to look at the regulatory developments in the EU.
Regulatory Reform in the EU
The most relevant EU regulation in this space is the Sustainable Finance Disclosure Regulation (SFDR), which came into effect in March of this year. The SFDR imposes mandatory ESG disclosure obligations on asset managers and other financial markets participants and is a major milestone in the EU's efforts to ensure a systematic and transparent approach to sustainability within financial markets, thereby preventing greenwashing and ensuring comparability.
By way of background, the SFDR was introduced by the European Commission alongside the Low Carbon Benchmarks Regulation and the Taxonomy Regulation as part of a package of legislative measures stemming from the European Commission's Action Plan on Sustainable Finance.
According to its official wording, the SFDR "lays down harmonized rules for financial market participants and financial advisers on transparency with regard to the integration of sustainability risks and the consideration of adverse sustainability impacts in their processes and the provision of sustainability-related information with respect to financial products."
The SFDR has imposed transparency and disclosure requirements on financial market participants and financial advisers such as banks, insurance companies, pension funds, and investment firms at both entity and product level, aimed at protecting end investors by enabling them to make informed decisions about their investments. These market participants and advisers are now required to be transparent about:
- Their policies on the integration of sustainability risks in their investment decision-making and advisory processes
- How they consider the adverse sustainability impacts of their investments (e.g., how the proceeds applied by borrowers have effects on ESG matters)
- The sustainability of their financial products
- How environmental or social characteristics being promoted are met (e.g., if an index has been designated as a benchmark, information on how that index is consistent with those characteristics)
- Where a financial product has sustainable investment as its objective and an index has been designated as a reference benchmark, information as to how the index is aligned with that objective and, if no index has been designated as a reference benchmark for such objective, an explanation as to how that objective is to be attained.
The disclosure requirements include:
- What firms must disclose and maintain on their websites
- The information that must be provided to investors
- Periodic reporting to investors
To comply with these obligations, relevant firms in the EU have had to make changes to their internal procedures and policies to comply with the new requirements, including in many cases investing in training staff in relation to the new obligations.