Risks emerge from patchwork European sustainability approaches
The opportunity for regulatory arbitrage in the EU may lead to further and tighter regulatory intervention
The lack of minimum standards backing up asset managers’ sustainable disclosures has created a patchwork of European local regulation, experts say, with the potential for asset managers to be disadvantaged based on their place of domicile – as well as for regulators to take action.
The EU’s Sustainable Finance Disclosure Regulation has put an obligation on fund managers to state how their funds match up to three levels of sustainability.
Under SFDR, Article 9 funds are those that have sustainability goals as their explicit aim. Article 8 funds have environmental or social characteristics among other goals, while Article 6 denotes funds without a specific sustainability agenda.
But the enforcement of sustainability regulations at a local level, set in place to stamp out greenwashing, may lead to a patchwork approach that could allow the opposite to occur in countries with less stringent regulators.
CMS partner Laura Houët says SFDR “is about disclosure rather than minimum standards, and the wide parameters of Article 8 and 9 do not help – even with the latest regulatory technical standards”.
She says disclosures themselves are of an inconsistent standard, with greenwashing remaining a risk until further rules come into force.
“We are seeing a lot of divergence between jurisdictions. The immediate consequence of the regulatory dissatisfaction will be investigations and minimum standards applied at a country level, which is likely to lead to more confusion overall, as well as difficulties in distribution,” Houët says.
Local regulators swing into action
Further expectations about the quality and format of SFDR disclosures will come in July 2022 with the enforcement of technical standards. In October, the latest of these created two new subcategories for funds that have an environmental impact, aligning SFDR with the EU taxonomy.
However, experts do not expect these technical notes to create minimum standards for asset managers to follow, with companies instead taking their lead from the tone set by their national financial regulators. "The regulatory technical standards will help to define the areas covered by the EU taxonomy and the sustainable finance disclosure regulation but will not necessarily help to prevent a local regulatory patchwork within the EU," says Detlef Glow, head of EMEA research at Refinitiv Lipper, part of data group Refinitiv.
Some regulators in particular appear to be at the limit of their patience.
A September report from the Swedish Finansinspektionen, reported by Aktuell Hallbarhet and, in English, by our colleagues at Ignites Europe, found that a fifth of the country’s 69 asset managers had failed to disclose a fund’s negative impact on sustainability factors as required by SFDR.
It follows a similar warning from the Dutch Autoriteit Financiële Markten earlier in the same month, finding that the information provided to investors to justify Article 9 designation for some funds was too general.
Despite Houët’s concerns, however, market data do not yet appear to show difficulties in distribution. Although the Global Sustainable Investment Alliance, an industry body, found that the SFDR’s introduction led to a shrinking universe of environmental, social and governance-labelled funds in 2020, research provider Morningstar has found that Article 8 or 9-designated funds could hold more than half of the assets in the SFDR universe by July 2022.
Nonetheless, experts remain concerned about the potential for differing regulatory standards between EU member states.
“A European framework which defines the minimum standards with local addition would mean that the regulation of a fund would depend on the respective domicile,” says Glow. “As a result we won’t have a level playing field anymore, since a fund which is for example domiciled in Germany may have to follow other rules than a fund which is domiciled in Luxembourg, despite the fact that the fund which is domiciled in Luxembourg can still be distributed in Germany.”
Glow suggests that international fund promoters would likely choose to domicile funds within the country with the lowest regulatory burden, while companies focused solely on clients in their own country would be beholden to a tougher regime.
But Houët says that, in the long term, “in order to be able to distribute across the EU, if there are no common standards in place, then we will look to the highest requirements”.
The European Securities and Markets Authority itself has previously sought to avoid a similar problem. According to Ignites Europe, the EU regulator requested in March that its national counterparts review managers’ first SFDR disclosures according to its draft technical standards to avoid divergence, despite these standards not being enforced until July next year.
“As a side note, such a patchwork of local regulations is not in line with the ambitions of the EU to build a capital markets union, which is seen as a major source to finance the growth in Europe – and therefore also for the EU action plan to finance sustainable growth,” says Glow.
Some have theorised that regulatory dissatisfaction could lead to interventions.
Heads turned among the asset management community in August when it was reported that the US Securities and Exchange Commission was investigating Deutsche Bank-owned DWS Asset Management for overselling its green credentials.
Gabriel Webber Ziero, head of regulatory advisory at ECOFACT, an ESG consultancy firm, says the continuing dissatisfaction with market practices among Europe’s regulatory community could lead to similar cases.
He characterises the attitude among some asset managers to SFDR implementation as one of “complacency”, particularly with regard to the delayed but incoming regulatory technical standards for SFDR.
“Even from a principle-based approach, which is what we have so far… according to Article 8 you need to clearly define which characteristics you are promoting and how you’re meeting them,” he says. Asset managers, he continues, often protest that this is too much, citing peers’ preferences for “a vague sentence” to suffice.
“The industry can’t be surprised if the regulators say, ‘Come on guys, what are you doing?’,” adds Webber Ziero.