Khepri's A to Z: ESG - Buy and Sell-Side Compliance
Background
In general, investors are increasingly conscious of how fund managers, corporate businesses and other relevant stakeholders consider and embed Environmental, Social and Governance (“ESG”) factors into their business models.
There are various global initiatives around Environmental matters which includes:
the periodic Conference of the Parties (or “COP”) to the United Nations Framework Convention on Climate Change (UNFCCC); and
IOSCO’s “ESG Taskforce”.
Local regulatory initiatives sit within this wider global framework.
In addition to the various UK regulatory initiatives (more on this below) there are parallel, and in some cases divergent / contradictory, initiatives being progressed by the SEC (in the USA) and the European Commission (in the EU).
In the UK, ESG regulatory initiatives are being targeted at each of:
UK Corporates;
UK Fund Managers;
UK Portfolio Manager; and
Distributors of Funds in the UK.
This article will mostly focuses on CP 22/20 - Sustainability Disclosure Requirements (SDR) and investment labels – and the latter three stakeholders listed above. The FCA intends to publish the policy statement in Q3, 2023 - watch this space!
The requirements
There are eight key elements of the SDR regime proposed by the FCA, which can be briefly summarised as follows:
Sustainable investment labels: A classification regime based on how products aim to invest, split into three categories: (a) Sustainable: investing in assets that are environmentally and/or socially sustainable (b) Sustainable improvers: investing to improve the environmental and/or social sustainability of assets over time, including in response to the stewardship influence of the firm ) (c) Sustainable impact: investing in solutions to environmental or social problems, to achieve positive, real-world impact.
Consumer‑facing disclosures: Accessible disclosures to help consumers understand the key sustainability-related features of an investment product. For all products.
Pre‑contractual disclosures: Setting out the sustainability-related features of an investment product. For products using a sustainable label.
Ongoing sustainability related performance information: Periodic information on how the product is performing compared with what was said at the point of sale. For products using a sustainable label.
Entity‑level disclosures: How firms are managing sustainability-related risks and opportunities
Anti-greenwashing rule: A general rule - sustainability-related claims must be clear, fair and not misleading.
Naming and marketing rules: To restrict the use of sustainability-related terms in the naming and marketing of products offered to retail investors that do not use a sustainable investment label.
Distributors: Requirements for distributors of in-scope investment products to retail investors in the UK to make the sustainable investment label and consumer-facing disclosures available to those investors.
Retail Investors
In the context of these rules, retail investors are those who are not per-se professional or elective professional investors and would include high-net worth investors and sophisticated investors.
Applicability
There is a very helpful applicability table on pages 20 to 23 of CP 22/20. We have in this article highlighted the applicability of the rules for four separate examples
Example 1: UK AIFM managing unauthorised AIFs with Retail Investors
In this example the firm is a Full Scope or Sub-Threshold AIFM what manages either UK or non-UK AIFs which are either open or closed ended. The AIFs are marketed to and include investors that are high-net worth and sophisticated investors who have not elected up or are not eligible to elect up to professional investor status. The funds are not listed on an exchange.
Example 2: UK placement agent privately marketing investment funds located in the UK or elsewhere
In this example the firm could either be an Appointed Representative or directly licensed by the FCA. They are likely to be an “adviser / arranger” or, if they have a wider set of permissions, only arrange deals in funds where they get paid by the fund manager a commission or retainer fee. The marketing strategy is to solicit investors who are part of the individuals known network. The funds are not listed on an exchange.
Example 3: UK investment platform hosting funds for sale in the UK
In this example the UK investment platform hosts funds for sale via a website and the platform facilities the investor coming into the fund. Potentially allowing them to sign subscription documents online but they do not provide a custody platform I.e. the investor holds the interest directly as an LP of the relevant fund or feeder fund. The funds are not listed on an exchange.
Example 4: Discretionary investment manager for UK
The firm is a MiFID Investment Firm and provides discretionary management services to individual clients via a mandate provided to them on a client-by-client basis. Their clients include UK AIFM managing unauthorised AIFs (not listed on an exchange) with Retail Investors.
Application of the UK's Sustainability Disclosure Requirements - click to enlarge
Next Steps
Firms should look out for the policy statement in Q3 2023. These rules (except for the greenwashing rule which is effective immediately) will come into force between 12 and 24 months after the publication of the policy statement.
