Investors are increasingly demanding a greater focus on sustainability and responsible
investment from their asset managers, and the private funds sector is certainly no
exception. In Europe, regulators are following suit, and new rules that will affect most
private funds that want to raise money in Europe have now taken shape.
In May 2018, the European Commission proposed a package of measures on sustainable
finance, which, as we reported at the time, included a requirement for
asset managers (including private equity and venture capital fund
managers) to take sustainability risks into account in their investment
decision-making, and to explain to investors how they do so. It also
included a proposal for a taxonomy (a classification system) to determine
whether an economic activity is environmentally sustainable and a
proposal for a new category of low and positive carbon benchmarks. These measures
formed part of the Commission’s broader attempts to meet the goals set by the Paris
Agreement on Climate Change.
One year later, the European Parliament has published agreed text on the disclosures to
be given by firms on the integration of sustainable investments and sustainability risks
in their investment process (the “Regulation”), while work on the other initiatives is
ongoing. “Sustainable investments” are broadly conceived as investments in an
economic activity that contribute to an environmental or social objective, with the
additional proviso that the investment follows good governance practices.
The Regulation will apply to a broad range of “financial market participants”, including
alternative investment fund managers (“AIFMs”), firms authorised under the Markets
in Financial Instruments Directive (“MiFID”) to provide portfolio management, and
managers of EuVECA and EuSEF funds. “Financial advisers” (including firms
authorised under MiFID to give investment advice) are also in scope. Insurers that
provide investment products, manufacturers of individual pension products (including
those not regulated at the EU level) and occupational pension schemes are also subject
to the Regulation.
As we reported last year, the scope of the Regulation widened during the legislative
process. The Regulation originally applied primarily to managers that pursue a
sustainable strategy. It now applies to all firms.
The Regulation is not explicit as to whether it applies to “incoming” non-EEA managers,
including US fund managers, when marketing their funds in EU states under available
national private placement regimes, but it seems likely that Member States will apply it
in practice to such managers (and the use of the generic term “AIFM” in the Regulation
certainly facilitates application of the Regulation to non-EU AIFMs).
Impact on Fund Managers—Incorporation of Sustainability Risks into Investment
Decision-Making Process. The Regulation seeks to ensure that fund managers
incorporate “sustainability risks” into their investment decision-making process.
“Sustainability risk” means an environmental, social or governance event that could
negatively affect the value of an investment. It means consideration of, for instance, an
environmental factor in the investment decision-making process to the extent it affects
the value (or volatility) of the investment—but it does not require a manager to
consider sustainability factors that have no impact on the investment’s value. There is
no qualification as to whether a sustainability risk should be material, although
managers will need in practice to determine the materiality and relevance of
sustainability risks to the value of the investments they make, as well as the availability
of data on the impact of sustainability risks on value.
The Regulation requires managers to publish information on their policies on the
integration of sustainability risks in their investment decision-making process on their
website. Managers are not required to publish the whole policy, but can do so if they
The Regulation introduces the separate concept of “principal adverse impact of
investment decisions on sustainability factors”. This only applies to firms that consider
the “adverse” impact of their investment decisions on “sustainability factors”, such as
the environment, in their investment process—even if they do not affect the value of an
investment. This is framed as a disclosure obligation at the “entity” level, encompassing
the whole firm’s approach to sustainability factors in its investment decisions. Firms
that do commit to consider sustainability factors more widely must publish information
on their website on how their due diligence policies incorporate these factors.
Information to be given will include the priority given to various sustainability factors,
actions taken to address the factors and adherence to responsible business conduct
codes. Firms that do not consider such factors will need to explain that this is the case,
give clear reasons for not doing so and indicate if and when they intend to consider such
factors. However, large firms (including firms that exceed an average number of 500
employees during their financial year) cannot benefit from the “comply or explain”
route—they must publish a statement on their website on how they consider
sustainability factors more widely in their investment due diligence.
The degree to which AIFMs will need to change their investment approach for existing
(as opposed to new) funds is unclear, although it is likely that firms will in practice
focus on the application to new products. In helpful acknowledgement of the
proportionality principle, the Regulation acknowledges that the degree to which due
diligence incorporates sustainability factors should take account of the firm’s size,
nature and scale of activities. The applicability of sustainability factors to a firm will
depend on the firm’s investment strategies, with the possibility for some firms to make
quite high-level disclosure, particularly if they consider that their strategy does not
necessarily accommodate the consideration of sustainability factors.
Firms must make similar disclosures in relation to given financial products, including
funds, at the “pre-contract” stage (for AIFMs, as part of the disclosures usually given to
investors in the fund’s PPM). Here, the obligation is to disclose whether a financial
product considers principal adverse impacts on sustainability factors—so large firms
that must publish the disclosure at the entity level are not necessarily required to follow
through with disclosure at the product level, such as where they conclude that the
product does not lend itself to the application of sustainability factors.
Many private fund managers do not make any information available on their funds on
their website, other than to approved investors behind a “firewall”. Although the
Regulation requires product-level disclosure to appear on websites, it appears that firms
in practice can continue to make this information available only to approved investors.
By contrast, firm-level disclosures on the consideration of sustainability risks on
websites will likely be required to be made public—highlighted by Evert van Walsum of
ESMA in a speech given on 13 May 2019, in which he referred to “Public disclosure of
so-called ‘principal adverse impacts’ of investment decisions on sustainability factors,
such as environmental and social matters (which apply to market participants on a
comply or explain basis, except for companies with more than 500 employees for which
the obligation is mandatory).”
As the Regulation notes, standardised disclosure will allow “end-investors” to make
better informed investment decisions and compare investment products on a like-forlike
basis more easily. It may also reduce the need for managers to complete separate
investor due diligence questionnaires.
Impact on Investors. As noted above, insurers that provide investment products (and
firms, other than very small firms, that provide advice on those products) are in scope
and must comply with the rules in a similar manner to fund managers. Likewise, the
Regulation applies to manufacturers of individual pension products (including those
regulated at the national law level and the forthcoming pan-European Personal Pension
Product) and occupational pension schemes (other than schemes with fewer than 15
members). From a private equity perspective, certain types of investors, such as
occupational pension schemes, are in scope, suggesting a significant future bias in their
investment policies towards sustainable investing. There is a separate EU workstream to
consider the integration of sustainability risks in the Solvency II Directive that governs
Impact on Financial Advisers. The Regulation has similar obligations for “financial
advisers”, which include firms authorised under MiFID to give investment advice. As for
managers, financial advisers must publish information on how they integrate risks in
their investment advice on their website, and publish information as to whether they
more widely take into account the “adverse” impact of their investment decisions on
“sustainability factors” in their investment advice (regardless of whether their clients
have expressed a preference for sustainable investments). Very small investment
advisers (that employ fewer than three persons) are exempt.
Products with Sustainable Investment as Objective. The Regulation introduces
additional disclosure obligations where a financial product has sustainable investment as
its objective. There will be prescribed and consistent disclosure standards on how these
objectives are met, the methodologies used to assess achievement of the objectives and
rules to ensure the consistency of any index used as a benchmark with the objectives.
These are, in part, designed to prevent “greenwashing” (which the European
Commission describes as “unsubstantiated or misleading claims about sustainability
characteristics and benefits of an investment product”). The details of the disclosure will
be in forthcoming regulatory technical standards.
Remuneration Policies. As an add-on to existing remuneration rules, firms in scope of
the Regulation must include in their remuneration policies (applicable to their staff)
information on how their policies (in terms of incentives and avoidance of conflicts of
interest) are consistent with the manner in which they take into account sustainability
risks, and publish that information on their website. This provision is not as prescriptive
as earlier versions, and does not, for instance, tie remuneration awards to the firm’s
overall sustainability achievements.
Separate changes to MiFID and the AIFM Directive
In a separate workstream, the European Commission has proposed changes to
Delegated Regulations under MiFID to require investment firms to ask their clients
about their preferences concerning sustainability issues and to take any such
preferences into account when advising their clients.
In addition, the European Securities and Markets Agency (“ESMA”) has recently
published technical advice to the Commission on how sustainability risks should be
incorporated into the AIFM Directive’s (“AIFMD”) organisational requirements (and
separate advice in relation to MiFID organizational requirements). AIFMs will be
required to take into account sustainability risks in their procedures for internal
decision-making and resolving conflicts of interest, and will have to ensure that their
senior management are responsible for taking into account sustainability risks
(although firms are not required to designate a single senior person as responsible). Of
relevance to private equity is that AIFMs must, where required to consider the “adverse”
impact of their investment decisions on “sustainability factors” under the Regulation (as
to which, see below), develop engagement strategies (such as the use of voting rights to
influence a company’s strategy) to apply sustainability factors at investee companies.
The proportionality principle—that takes account of a firm’s size, scale and nature of its
activities—applies to these new requirements.
Significantly, ESMA said that it has received calls for a compulsory taxonomy on the
meaning of environmental, social and governance factors making up sustainable
investments—given the possibility of investors being misled by incorrect or
inconsistent use of these terms. While such a taxonomy is beyond its remit, ESMA will
nonetheless include the calls for a taxonomy in its final report to the Commission, with
the potential for the Commission to engage ESMA in this project at a later date.
Separately, the Regulation requires the EU regulatory authorities to develop rules on the
content, methodologies and presentation of information in relation to certain aspects of
the disclosures required on the consideration of sustainability risks in their investment
processes, although it is unknown how detailed these rules will be.
As a next step, the European Council will adopt the proposed Regulation. The
Regulation will enter into force 20 days after it is published in the Official Journal of the
EU but then apply 15 months from the date of publication, giving firms sufficient time
to implement any new due diligence requirements and make the new disclosures. The
Regulation is not likely to be effective until the beginning of 2021, at the earliest.
The obligation for large firms to publish a statement on their website on how they
consider sustainability factors more widely in their investment due diligence enters into
force 18 months after the Regulation enters into force. The obligation to make the
related disclosure for each product also has delayed application (three years after entry
It is likely that the application date of the separate changes to MiFID and the AIFM
Directive will be aligned to the application date of the Regulation.