Global Regulation, Local Solutions Emerging Themes 2020 - Page 44



GOVERNANCE
As policymakers have become more interested
in how asset managers achieve their nonfinancial goals, we are seeing a long-term
trend emerge of environmental, social and
governance (“ESG”)/sustainable, responsible
and impact investment (“SRI”) standards driving
regulatory compliance. ESG and SRI are also
beginning to influence standards of care, with
investors and lenders increasingly using ESG/
SRI measures to evaluate the performance of
investments. Asset managers who implement
their commitment to sustainability and who hold
consultants, managers and advisors to account,
are likely to create a competitive advantage
for themselves – and a “sustainability multiplier
effect” in the market.
This legislation has a much
shorter implementation
period than most other EU
financial services legislation,
with affected firms only
having 15 months to
become compliant
LEGAL AND REGULATORY ENVIRONMENT
There is strong political drive for responsible and
sustainable business conduct – in the UK, EUwide and globally. The UK backdrop, alongside
various industry-led initiatives, includes the
FCA’s support for introducing climate-related
mandatory disclosure requirements for
regulated firms (as set out in its October 2019
Feedback Statement on Climate Change and
Green Finance), and the Department for Work
and Pensions’ recommendation that pension
scheme trustees prepare an optional policy
on how investment strategies consider nonfinancial factors, such as ethics, social and
environmental impact, and quality of life.
EMERGING THEMES 2020
In November 2019 the EU adopted a package
of measures on sustainable finance. The
reform’s key tenets are taxonomy, disclosure,
investor duties, benchmarks and suitability.
Asset managers will be required to integrate
sustainability risks into their operating models,
provide more detailed disclosures on ESG
policies and sustainability risks and increase
due diligence on the ESG profile of funds.
This legislation has a much shorter
implementation period than most other EU
financial services legislation, with affected
firms only having 15 months to become
compliant (with an additional year for the first
annual reports containing ESG/sustainability
information). Given this short window firms will
need to begin their implementation planning
early in 2020. Further, as EU delegated
legislation is expected to impact MiFID II and
IDD suitability testing, firms should also be
prepared to take ESG considerations and
preferences into account in the suitability
assessments they undertake to see if proposed
investments are appropriate for a client.
Investors and managers are already committing
to aspirational and voluntary investment
principles to mandate a more systematic
approach to ESG integration into investment,
risk and organisational processes. A growing
number are signatories to the UN Principles
for Responsible Investment. This involves a
manager’s commitment to six voluntary and
aspirational investment principles, including:
considering ESG issues when making investment
decisions; seeking disclosures from ESG
entities in which they invest; and reporting
on ESG activities.
The new taxonomy should
give greater transparency
for end-investors, allow
better comparison between
products and reduce
opportunities for “greenwashing”
CLARITY AND CHALLENGES
Policymakers are keen to provide clarity on what
sustainable investments are by creating an EUwide classification system to provide a common
language to identify economic activities that
can be considered environmentally sustainable.
The new taxonomy should give greater
transparency for end-investors, allow better
comparison between products and reduce
opportunities for “green-washing”. Although
this taxonomy is EU-centric and only likely to
be mandatory for products that are marketed
as a “sustainable investment”, we expect it to
become the global language of mainstream
impact investment.
Regulatory consistency across the various
standards, to avoid duplication or divergence,
is key. Other challenges include specifying
appropriate time horizons (particularly since
many climate-related risks may crystallise
beyond a firm’s typical planning horizon) and
modelling and methodological difficulties.
CONCLUSION
We are seeing sustainability
becoming more central to
managers’ and investors’
considerations. 2020 will be a
crucial year for codifying and
embedding the EU sustainable
finance measures, along with similar
initiatives emanating from the UK
and other jurisdictions. The current
investment landscape presents an
opportunity to align operating,
legal and governance approaches
to ensure long-term value through
sustainable business conduct.
We expect in many cases this will
involve re-examining portfolio
company governance as voluntary
frameworks develop into
legal requirements.
Side letter provisions are becoming more
common, for instance that the manager
maintains and/or introduces appropriate
ESG strategies to the management of portfolio
investments. Another framework recently
consulted on, and which may become
increasingly recognised by the funds industry,
is the Sustainable Development Goals (“SDG”)
Impact Practice Standards for Private Equity
Funds. This UN initiative provides a practical
end-to-end checklist designed to integrate
impact into fund design and execution.
MATTHEW BAKER
Partner,
London
44/
CHRIS ORMOND
Associate Director,
London
/45

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