On disclosure and transparency in the investment management sector (or why the industry should not treat me like a moron)
I have recently asked my financial advisor to review my pension funds and recommend me some ESG funds (ESG stands for Environment, Social and Governance and an ESG fund means that the fund manager has somehow integrated these factors in their investment decision making process). A few weeks later the FA replied with a copy of factsheet for something called Responsible Portfolios. The leaflet reads:
Responsible Portfolios provide investors a range of six multi-asset responsible portfolios that invest across a diverse range of third-party investment funds managed with various responsible criteria (where possible) with the aim of meeting the needs of a range of different investors. The Portfolio aims to generate growth over the long-term being managed in line with a defined level of risk while taking into consideration a responsible investing framework aligned to the UN Sustainable Development Goals.
What the hell am I supposed to do with this information?
‘Funds managed with various responsible criteria (where possible)’. Where possible? I was left wondering if there are cases of ‘irresponsible criteria’…
‘Taking into consideration a responsible investing framework aligned to the UN Sustainable Development Goals’. Aligned to which SDGs? All the 17 of them?
I could carry on here but you got the idea. And that was the entire information about the fund’s ‘sustainability credentials’ in its 4-page long marketing piece. It seems that when dealing with ordinary retail investors like me, babbling anything that sounds ‘sustainable’ will suffice.
EU regulations to the rescue
There are a couple of new regulations that will hopefully address disclosure and transparency issues in the retail investment markets. I will spare you some of the more daunting details, but these regulations are called the Sustainable Finance Disclosure Regulation (SFDR) and the Taxonomy Regulation.
Disclosures to end investors is an effective tool to prevent greenwashing. As per the SFDR, greenwashing refers to the practice of gaining an unfair competitive advantage by marketing a financial product as environmentally friendly, when in fact basic environmental standards have not been met.
Disclosure requirements will apply at fund manager and product levels and will take many forms:
§ integration of sustainability risks, which means fund managers will have to disclosure how they incorporate such risks into their investment decision making processes.
§ consideration of adverse sustainability impacts, aiming to increase transparency of negative sustainable impacts at management and product level (fund).
§ products with sustainable investment objectives, funds that have clear, specific sustainability objectives and positive impacts on the environment and society will have to designate an index as a reference benchmark (or explain how the sustainable objectives will be achieved in case they do not do so).
§ products promoting environmental or social characteristics, such funds may not have the same sustainable ambitions as the ones above but will observe similar disclosure requirements. These funds may aim to ‘give a hand’ towards sustainability goals by, for example, ensuring investee companies in which investments are made follow good governance practices and that the principle of ‘do no significant harm’ is followed.
There are many other requirements coming out from this pair of regulations but, as I said before, I will spare you of these details since no Sofa Activist deserves such punishment. The disclosures shall be made in pre-contractual information to investors, in annual reports and on the fund manager’s website.
More importantly, these regulations will bring harmonised disclosure requirements across the EU, allowing end investors to compare information and direct capital flows towards sustainable investments. Also, without this convergence, different disclosure standards could potentially create distortions in the competition among market participants and reduce transparency.
It is believed that the consideration of sustainability factors in the investment decision‐making process will increase the resilience of the real economy and the stability of the financial system. It is therefore essential that financial market participants provide clear, concise, relevant information to enable end investors to make informed investment decisions.
The spirit, and not only the letter of the law
While these regulations are expected to apply very soon — the SFDR, for example, comes alive on 10 March 2021 — it will take many years for their full impact to be felt. Then, take in consideration all the trouble created by the coronavirus, the fact that the three European Supervisory Agencies (ESAs) are still working on the Regulatory Technical Standards (RTS) that will provide market participants with detailed guidance on disclosure requirements, and the likely absence of adequate sustainability data and we can conclude that there will be no Big Bang moment next year. It will rather be a more gradual process over the years where sustainability indicators are incrementally adjusted as data quality improves.
The point is that the direction of travel has been set and investment firms must know now where they should go. The regulations could not be more direct by stating that the information to be disclosed ‘shall be clear, succinct, and understandable to investors. It shall be published in a way that is accurate, fair, clear, not misleading, simple, and concise and in a prominent easily accessible area of the website’. Simples!
Investment firms must, primarily, observe the spirit of the law and clearly communicate the sustainable risks and impacts of their policies and portfolios and make these assessments salient and visible, not hidden on the bottom of their website pages. Ok, I take it back, maybe when dealing with disclosure and transparency issues, fund managers could treat me as a moron if they make my life easier.
Author: Jeronimo Souza, sustainable finance lead at now-on
