ESG mutual funds are set for increased regulatory scrutiny around the world in 2023, as investor demand for sustainable strategies increases, adding pressure on asset managers to market their investment products more carefully.
Immediately on the horizon is Level 2 of the European Sustainable Financial Disclosures Regulation (SFDR), which requires asset managers to provide more information about their funds’ ESG approach, sustainability risks and impacts.
From 1 January 2023, the disclosure regime will apply to Ucits funds, alternative investment funds, individually managed portfolios and sub-advisory mandates with financial advice.
Most of the funds sold to the public in Hong Kong are Ucits funds or authorized cross-European mutual funds, so any changes affecting Ucits products will be felt here too, experts said. More than 100 ESG-branded funds are distributed in Hong Kong, according to the Securities and Futures Commission.
SFDR 2 income
While asset managers will spend 2022 preparing for this regime, even at this late stage several fundamental issues remain unclear.
While Amundi welcomes the introduction of regulations regarding responsible investment markets with the aim of improving transparency and protecting end investors, the current regulatory framework does not yet allow the financial industry to respond in a consistent manner. It should be considered ‘sustainable’ or not,” the French property manager told a statement. Asian Investor
That sentiment was echoed by Hortense Bio, global head of sustainability at mutual fund regulator Morningstar, who said asset managers were still waiting for the EU Commission to clarify the definition of “sustainable” investments.
Asset managers are using their own interpretation [regulation’s] An essay on their own ways to calculate sustainable investments. Depending on the method of operation, you can get completely different results, so everything is far from being sorted, “said Baioy.
Downgrades and upgrades
Level 1 of the EU SFDR came into effect in March 2021 and required asset managers to classify funds sold in the region as Article 6, 8 (general ESG) or 9 (sustainable), depending on their sustainability objectives.
Fund companies are clearly feeling commercial pressure to have more funds that meet at least Article 8 requirements.
More than 380 products changed SFDR status in the third quarter, adding to 713 funds in the second quarter of 2022. Most of the funds were upgraded to Article 8 from 6, while 57 were downgraded by more than six to Article 8 from 9. month, Morningstar reported.
Prior to the Phase 2 revised disclosure, many asset managers reassessed their fund allocations and downgraded Article 9 products to Article 8.
Dutch asset manager NN Investment Partners was among the first asset managers to divest Article 9 funds into Article 8 funds in the second quarter and divest nearly 20 more strategies in the third quarter, Morningstar said.
Other fund managers that have reduced funds during the year include Axa Investment Managers, Deka Investment and Neuberger Berman.
“Given this still evolving regulatory environment, Amundi has taken a conservative approach,” the firm said in a statement. This election resulted in the redistribution of almost all Article 9 funds to Article 8.
Amundi manages around 100 SFDR Article 9 funds worth around €45 billion at the end of September 2022. The funds were roughly split between ETFs and active management, it said in a statement.
Hong Kong effects
Such changes also have implications for funds distributed in Hong Kong.
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“Changes in fund names, strategies or key features (such as becoming an Article 8 fund from an Article 9 fund) mean that the filings, including the Hong Kong Special Product Key Fact Statement, must be updated and resubmitted for SFC approval. ” said Philippa Allen, CEO and Founder of ComplianceAsia Consulting.
As ESG-related requirements have become part of institutional investors’ due diligence requirements in Hong Kong in recent years, the costs associated with the changes may be justified, said Hiban Ahmed, consultant and head of the Hong Kong investment fund practice at Linklaters.
Hong Kong-based wealth managers who are part of large global groups can benefit greatly from the experience of European group entities, helping them navigate the SFDR compliance-curve more efficiently, Ahmed said. Asian Investor.
The SFDR is designed to help investors know exactly what they’re buying, given the growing concerns around “greenwashing,” companies making misleading or unsubstantiated claims that they’re sustainable and environmentally friendly.
However, the past 18 months have seen a significant increase in the amount of funds tracking — and asset managers actively considering — investment strategies linked to sustainability, Ahmed said.
“We expect this trend to continue, especially as investors focus on sustainability as part of their capital allocation decision-making processes in the coming years,” he said.
More to come.
SFDR is not the only major regulation that the fund industry is grappling with.
The UK published a consultation paper in October on the use of sustainable fund labeling and disclosure requirements, while the US is considering more disclosure and a new classification of ESG funds.
Japan’s Financial Services Agency seeks to revise guidelines around ESG funds. China is rolling out green fund labeling rules, according to media reports.
Reconciling regulatory requirements in different parts of the world will be a big challenge for international investment managers.
“These updated disclosures are part of a global trend and are often beneficial to investors. However, efforts are needed to harmonize regulations and disclosure requirements in major markets to facilitate comparison by investors,” said Simon Wong, Partner and Veronica Fung, Trainee Lawyer at Law Firm Wirs.
ComplianceAsia’s Allen added: “Small differences in cross-border distribution can cause problems, so it’s important that global regulators try to be as consistent in their approach as possible.
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