How regulation will further enhance sustainable investing

Level II of the EU’s Sustainable Finance Disclosure Regulation (SFDR) takes effect from January 2023. The main enhancement is in how sustainable investments are defined, and compulsory disclosures about the impacts that they make on the ground.

It follows the launch of the SFDR that came into force from March 2021 as part of the EU’s wider Sustainable Finance Action Plan. This represented one of the most impactful pieces of regulation to hit the investment management industry since MiFID II beefed up reporting and transparency in 2018.

Aside from producing a level playing field that is better understood by end investors and the general public, the regulation aims to prevent greenwashing – where an entity claims to be sustainable when they are only making token gestures. There are three types of fund categorization under the Articles of the SFDR:

• Article 6 funds: Those that do not promote their environmental, social or governance (ESG) characteristics.

• Article 8 funds: Where a financial product promotes, among other characteristics, environmental or social characteristics, or a combination of those characteristics, provided that the companies in which the investments are made follow good governance practices.

• Article 9 funds: Where a financial product has sustainable investment as its objective and an index has been designated as a reference benchmark.

Robeco has spent much of 2022 preparing to implement Level II and what it will mean for documentation such as prospectuses. While this does not affect the core sustainable investment process that Robeco has practiced for decades, a number of funds were reclassified under the new rules.

“The financial industry will need to become very specific on how environmental and social issues are promoted, and how risks are taken into account,” says Malene Christensen, Sustainable Investment Specialist at Robeco. “The level of transparency required should help to combat greenwashing.”

“With Level II coming into effect in 2023, fund selectors and asset owners now have access to a much wider range of SI information on the funds they buy. It’s really important that this is used, however, if we are going to see the change we want to achieve in the world.”

Another key change from January 2023 is that the Principle Adverse Impact Indicators (PAIs), which describe the effect that investments have on wider society, must be disclosed for any fund claiming to be sustainable. Robeco has spent more than a year creating the data collection and reporting framework necessary to meet this requirement.

All human activity impacts the environment or social fabric in some way, and this is reflected in the business operations of the companies in which Robeco and other asset managers invest. This ranges from environmental issues such as carbon emissions (E) to working practices such as diversity (S) and corporate behavior regarding profit incentives (G). Since this must all now be disclosed, all client documents have been upgraded with the new information.

“Fund prospectuses have been updated to reflect the necessary changes required under SFDR Level I and now II, including information on how each fund has been classified, and what are the PAIs of each one,” says Kenneth Robertson, client portfolio manager for sustainable investing with Robeco’s SI Center of Expertise.

“At the fund level, Robeco expects to start reporting fund performance on PAIs from January 2023. The indicators necessary per strategy will be outlined in the prospectus and other relevant documents.”

“Funds aligning with Article 9 will address all the adverse impact indicators that are mandatory to report. Funds classified under Article 8 and 9 will subsequently report on actions taken to mitigate adverse impact on a yearly basis, through regular fund reporting.”

Much of this is ‘business as usual’ for Robeco. We have practiced ESG integration since 2010, and this is now applied across the entire range of fundamental equity, fixed income, quantitative and bespoke sustainability strategies. Robeco also has a strict exclusion policy and a structured Active Ownership approach using voting and engagement to further the sustainability of companies.

Taken together, the purposeful pursuit of sustainability factors means the majority of Robeco’s strategies will fall under the Article 8 banner. What has moved on, though, is that there is now a much greater emphasis on assessing the impacts that funds make, with the Sustainable Development Goals (SDGs) providing a particularly useful means of measuring this.

Such impacts can be measures by Robeco’s SDG Framework, which assigns scores to the contributions of companies. This will directly affect how funds are classified under the Article 9 banner, given the requirement that they invest solely in sustainable investments.

The regulation itself places a strong emphasis on transparency. “The greater the number of sustainability claims that a manager makes related to an investment product, the more that product is subject to disclosures,” says Christensen.

“There is now greater scrutiny on the binding sustainability elements in the investment strategy, such as the percentage of investments in Taxonomy-aligned activities.”

“To this end, we hope and expect that the current focus on classifications will be replaced with a focus on the underlying elements, such as the percentages of sustainable investments in the fund, its Taxonomy alignment, and the PAIs that are applicable.”

It has been a lot of work over the past few years. A project team of more than 30 people has been working on making sure Robeco adheres to the regulations, originally for Level I and now for Level II. Investment teams worked with the company’s product management team, legal officers, the Compliance department and external advisors and regulators to make sure all funds can meet the relevant criteria and disclosures.

Disclosures have been made at both the individual product level and the entity level since March 2021. This has included a new sustainability risk policy, renumeration policy, and a suite of disclosures giving more insight into the methodologies used to underpin our ESG integration and impact methodologies.

One complicating factor has been a series of delays around the publication of the regulatory technical standards, known as ‘Level II RTS’, stipulating the exact metrics, methodologies and further guidelines of the exact meaning and technical standards applied to each article. Originally planned for 2021, these standards did not become available until February 2022, delaying the implementation of Level II from mid-2022 to January 2023.