ESG mutual funds are set for greater regulatory scrutiny across the globe in 2023, adding pressure on asset managers to market their investment products more carefully as investor interest in sustainable strategies intensifies.
Immediately on the horizon is level 2 of Europe’s Sustainable Finance Disclosures Regulation (SFDR), which requires asset managers to give more information on their funds’ ESG approach, sustainability risks and impact.
The disclosure regime, which kicks in from January 1, 2023, applies to Ucits funds, alternative investment funds, separately-managed portfolios and sub-advisory mandates, along with financial advice.
The majority of funds sold to the public in Hong Kong are Ucits funds, or approved cross-Europe mutual funds, so any changes that impact Ucits products will be felt here as well, experts said. More than 100 ESG-labelled funds are distributed in Hong Kong, according to the Securities and Futures Commission.
SFDR 2 INCOMING
While asset managers have spent 2022 preparing for this regime, several basic issues remain unclear even at this late stage.
“While Amundi is pleased to see that regulations have come into force regarding the responsible investment market, with a view to improving transparency and protecting end investors, the current regulatory framework does not yet allow the financial industry to respond in a uniform manner as to what should be considered ‘sustainable’ or not,” the French asset manager said in a statement to AsianInvestor.
That sentiment was echoed by Hortense Bioy, global head of sustainability at mutual fund tracker Morningstar, who said that asset managers are still waiting for the European Union Commission to clarify the meaning of “sustainable” investments.
“Asset managers are using their own definitions and interpreting the [regulation’s] text in they own way to calculate sustainable investments. Depending on the methodology, you can get completely different results, so everything is far from being sorted,” Bioy said.
DOWNGRADES AND UPGRADES
Level 1 of the European Union's SFDR came into force in March 2021, and required asset managers to classify funds sold in the region as Article 6, 8 (general ESG), or 9 (sustainable), depending on their sustainability objectives.
Fund companies are clearly feeling the commercial pressure to have as many funds as possible meeting at least Article 8 requirements.
Over 380 products changed SFDR status in the third quarter, adding to the 713 funds that changed status in the second quarter of 2022. Most funds were upgraded to Article 8 from 6, while about 57 were downgraded to Article 8 from 9 over the six-month period, Morningstar reported.
Ahead of the Level 2 upgraded disclosure regime, several asset managers reviewed their funds’ classification and downgraded Article 9 products to Article 8.
Dutch asset manager NN Investment Partners was among the first asset managers that reclassified Article 9 funds into Article 8 funds in the second quarter, and downgraded close to 20 additional strategies in the third quarter, said Morningstar.
Others fund managers that downgraded funds through the year include Axa Investment Managers, Deka Investment and Neuberger Berman.
“Given this still evolving regulatory environment, Amundi has taken a conservative approach,” the firm said in its statement. “This choice has led to the reclassification of almost all of its range of Article 9 funds into Article 8.”
Amundi managed approximately 100 SFDR Article 9 open funds of around €45 billion at end-September 2022. The funds were roughly evenly split between ETFs and active management, according to the statement.
HONG KONG EFFECTS
Such changes have implications for funds distributed in Hong Kong as well.
“Changes in fund names, strategies or key attributes (like being an Article 8 fund rather than Article 9 fund) mean that the offering documents including the Hong Kong specific product key fact statement will need to be updated and re-submitted for SFC approval,” said Philippa Allen, CEO and founder of ComplianceAsia Consulting.
Costs associated with the changes may well be justified as ESG-related requirements have increasingly formed part of institutional investors’ due diligence requirements in recent years in Hong Kong, noted Hibban Ahmed, Linklaters counsel and head of its Hong Kong Investment Funds practice.
Hong Kong-based asset managers who are part of larger global groups have also been able to benefit significantly from the experience of their European group entities, helping them get up the SFDR compliance-curve more efficiently, Ahmed told AsianInvestor.
SFDR is meant to help investors know exactly what they are buying into, which has become crucial given rising concerns around “greenwashing”, when companies make misleading or unsubstantiated claims of being sustainable and environmentally friendly.
Nevertheless, over the past 18 months there has been a noticeable increase in the number of funds pursuing – and asset managers actively considering – sustainability linked investment strategies, according to Ahmed.
"We expect this trend to continue, particularly as investors place increasing emphasis on sustainability related considerations as part of their capital allocation decision making processes over the coming years,” he said.
MORE TO COME
SFDR isn’t the only big regulation the fund industry is grappling with.
The UK published a consultation paper in October on the use of sustainable fund labelling and disclosure requirements, while the US s also considering greater disclosure and a new classification of ESG funds.
In Japan, the Financial Services Agency is seeking to revise guidelines around ESG funds. China is also mulling green fund labelling rules, media reports said.
Reconciling regulatory requirements in different parts of the world will be a big challenge for global investment managers.
“These enhanced disclosures are part of the global trend and are often useful for investors. However, efforts are required to harmonise the regulations and disclosure requirements across the major markets to facilitate comparisons by investors,” said Simon Wong, partner, and Veronica Fung, trainee solicitor, at law firm Withers.
ComplianceAsia’s Allen added: “It is important that the global regulators try and be as integrated as possible in their approaches as small differences can create a problem when it comes to cross border distribution.”