ESG: The global outlook for 2023

Claire: Thank you for joining us today. My name is Claire Simm, and I’m the CEO of Waystone Compliance Solutions business in Europe. Our Waystone Compliance Solutions business supports clients across the globe with offices in Europe, across the U.S., the Middle East, and Asia. As a truly global partner, we work with clients to align investment strategies and operational processes with the ever-shifting regulatory environment. We are delighted to have you join us for our panel discussion today, where you’ll hear from some of our ESG experts regarding the regulatory outlook for 2023 and investor expectations around ESG.

At Waystone, we pride ourselves in being the world’s leading risk governance and compliance firm, supporting managers with over $1 trillion in AUM. We recognize that ESG poses both opportunities and challenges, but there’s also a no one-size-fits-all approach into how managers can incorporate ESG at both the corporate and product level. Similarly, regulators and investors have differing ESG priorities, but with the increased focus on ESG, there is increased risk of regulatory and legal action resulting from claims around mis-selling, even in those jurisdictions that don’t currently have ESG regulations in place.

At Waystone Compliance Solutions, we are here to help you, whether you need specific help to upgrade your Article 6 product to an Article 8 product, whether you want to help prepare for and respond to invest to ESG due diligence, assistance in monitoring and reporting on ESG metrics, both those required from a regulatory perspective and specific investor needs given the increased prevalence of ESG clauses within side letters. We can also review and provide assurance on your ESG policies, procedures, and disclosures, and can assist with the design and implementation of ESG policies, frameworks, and control procedures to address any potential gaps you may have. Our solutions are tailored to your firm, your strategies, and are scalable. If there’s anything we can help you with, please do reach out to your Waystone Compliance consultant, myself, or any of today’s speakers, and we’ll be delighted to talk to you.

We have an excellent panel of speakers from across our global team, which will be moderated by Rebecca Palmer. Rebecca is an executive director here at Waystone and leads the ESG Advisory and Governance Practices. She’s based in the Cayman Islands and chairs Waystone’s ESG Global Steering Committee. Rebecca is co-chair of 100 Women in Finance in the Cayman Islands, a fellow of the Institute of Chartered Accountants in England and Wales, and she’s the alumni of London Business School and Said Business School, University of Oxford. I’ll now hand over to Rebecca to get today’s discussion started. Thank you.

Meet the ESG Panelists

Rebecca: We have a very ambitious target of going around the world in 40 minutes, but with some of the complexities of ESG, perhaps Phileas Fogg’s 80 days might have been a more forgiving timeframe for us. Taking us on this journey, we’ve assembled an all-star panel for you today, and I wanted to give each of the panelists a few minutes to introduce themselves. So, perhaps it makes sense to start east then move west. Nithi?

Nithi: Thank you, Rebecca. Hi, everyone. Very happy to be here today. Quick background to myself. I’m the executive director at Waystone Compliance Solutions in Singapore. I have a great team on the ground here. We work with a large number of financial institutions, including asset managers. We help them in a variety of a number of things, including license applications, helping them with various projects, providing ongoing compliance support, and most definitely helping them with ESG projects at the moment. And we’re looking forward to, you know, speaking more and sharing more on what’s happening here.

Rebecca: Great. Thank you. So, perhaps, Nigel.

Nigel: Yes. Thanks, Nithi. Thanks, Rebecca. My name is Nigel Pasea, and it’s also a pleasure for me to be speaking to you guys today. I’m the managing director of Waystone Compliance Solutions in the Middle East. We’re based in the UAE with offices in Dubai and in Abu Dhabi. We’ve been operating here in the region since 2006, and now nearly 16 to 17 years of experience. Obviously, ESG wasn’t a focus throughout much of those 16 years, but increasingly has been, and I hope to be able to share some of the developments in the region with you today. Thank you.

Rebecca: Thank you.

Carwyn: Thanks, Nigel. My name is Carwyn Evans. I’m a managing director at Waystone Compliance Solutions in the UK where we serve predominantly the London market, but wider financial services firms in the UK. We’ve been in existence since the late ’80s, so about 35 years we’re coming up to here. Cover a whole range of services predominantly in the investment management sector. But the ESG workflow over the last two years has been a significant part of what we do, helping UK managers tackle evolving UK regime but also manage their interaction, I guess, with the European regime.

Sinead: Thanks, Carwyn. So, hi all. Delighted to be part of the webinar today. I’m Sinead Murray. I’m an executive director within the Waystone Compliance Solutions Group. I’m currently based in our Luxembourg office. I did originally join Waystone in Ireland back in 2016 before relocating to Luxembourg in 2018. I’ve over 10 years experience in compliance within the fund industry, working mainly in management companies and also within one of the big four. I’m a Licentiate of the Compliance Institute of Ireland, and I’m also member of the ALCO Association here in Luxembourg, and quite heavily involved at the moment with the ESG advisory services.

Cameron: Hey, guys. I’m Cameron Flagg. I’m with Waystone Compliance Solutions in the U.S. My experience is mainly regulatory. I started my career off working for several regulatory agencies such as FINRA, CBOE, and NYSE. And after coming to Waystone, we now focus on servicing clients that mainly are either private fund managers or broker-dealers. And so, I’m very excited to be here to discuss how ESG is impacting our mostly private fund clients and the developments in the U.S.

Rebecca: Great. Thank you, everyone. Sinead, it makes sense to start with you given that the EU has been leading the way with ESG regulations. Could you give us a recap on the regulations currently in effect and the outlook for 2023?

Recap on ESG Regulations in the EU

Sinead: Sure. That’s correct. It’s definitely been a busy period within the EU, and it looks like 2023 is going to be another very busy year from a European regulatory perspective. So, it already kind of started on the 1st of January this year with the implementation of Level 2 of SFDR, and also the entry into force of the Delegated Act on the Gas and Nuclear Energy of the EU Taxonomy. So, what we are expecting in Q1 of this year is that, hopefully, there should be a new Q&A from the European Commission, which is going to provide some clarification, we hope, on some points which have been raised at the end of last year. Likewise, in Q1, we are expecting that the Commission should start working on a comprehensive kind of assessment of the implementation of SFDR, so this should include kind of workshops within the industry, but also some public consultations, so, hopefully, giving that bit more clarity to everyone.

Then towards the end of 2023, we are expecting that the European supervisory authorities will publish their final regulatory technical standards on the PAI framework. So, definitely, a busy year ahead, as I mentioned, but mainly, if we just firstly focus on the requirements that have come into effect as from the 1st of January, though at the moment we do have the pre-contractual documentation of the SFDR, Annex 2 and 3, which applies to all new funds and all funds which are open-ended. We have the website disclosures, which apply to Article 8 and 9 funds, that is regardless as to whether the fund is open or closed-ended. Our periodic reporting, which has also kicked in as from 1st of Jan, this is for our financial reports. And finally, our PAI disclosure publication at entry level. This is due on the 30th of June this year.

So, maybe if we go a little bit further back than this, we did have a Q&A at the very end of 2022 from the Joint Committee of the European Supervisory Authorities on the SFDR Delegated Regulation. So, this did give quite a lot of clarity. It covered six areas in total with 70 questions and answers, so quite a hefty Q&A. I’ll just touch maybe briefly on some points that they give some clarification to. Speaking of PAI, they did clarify that the ESAs do expect that the disclosure on PAI should cover all investments of the product. So, irrespective of the model, whether it be delegation or not.

Likewise, around the taxonomy-aligned investment disclosure, they did acknowledge that the lack of data on the market is still quite a challenge for financial market participants. And the response kind of ultimately being that for the moment we may just have to rely on what data is there at this point in time. However, this hurdle does seem that little bit less pressing when it comes to investments in undertakings that will fall under the scope of the future CSRD. So, hopefully, that will bring some optimism to it. So, the CSRD will ultimately kind of aim to address any sort of shortcomings on transparency and disclosure of non-financial information. So, it’s looking like by 2025, this will also apply to large non-listed companies given they meet certain criteria be it the 250 employees, the 40 million in turnover, and/or the 20 million in assets. So, that is also coming down the pipeline.

And maybe just before I pass back, I might just touch briefly on the ESMA consultation paper. This was with regards to the guidelines on fund names. So, as you know, not a particularly new topic, but they did issue a new consultation back in November of last year. So, two proposals here, proposal A being around fund names. So, if a fund has any ESG-related words or buzzwords in its name, that a minimum proportion of at least 80% of its assets should be meeting the ERS characteristics or sustainable investment objective. But again, ESMA is trying to get some input from the market and to see kind of how this should be put into place and practice.

And the second proposal is a little bit tougher. If a fund has the word sustainable or any other term derived from sustainable, the fund will have to allocate 80% of what was described in proposal A, at least 50% of that 80 to a proportion of sustainable investments. So that is still a consultation process. Of course, ESMA will review, you know, responses from market participants before issuing a final report, but, again, that is something that will be coming down our tracks.

Rebecca: So, a lot.

Sinead: Yeah, quite a lot. Yeah, unfortunately.

Rebecca: Yeah. No, it’s been a very busy period. And I guess, in the run-up to, you know, Level 2 of SFDR kicking up, kicking in on the 1st of January 2023, obviously, you know, we’ve had a number of our clients have taken advantage of the fast-track process for filing those annexes. What feedback have you had to date from the regulators?

Sinead: Yeah, so to date, the CSSF has been probably the most active feedback-wise. They did issue an FAQ on this on the back of their fast-track procedure, given that they had that earlier deadline of the end of October. So, they did give that bit of clarity around the exclusion-only strategies, stating that it’s not really acceptable for an Article 9 fund, and that it needs to be far more detailed for your Article 8 funds in exactly how the E or the S characteristics are being met.

They also gave kind of clarity with regards to the website disclosures, just reinforcing that ultimately the management company are responsible for the disclosures regardless of the delegation. And a final point being just around the confirmation of the minimum thresholds that these are indeed considered binding commitments of the investment strategy. So, if these aren’t met, it would be considered a breach. So, yeah, I think even for just from one regulator’s feedback, we are seeing the application of SFDR is quite stringent. They’re looking for naturally quite a lot of detail. And, you know, we do need to keep in mind that there’s already been quite a lot of, you know, fines issued for greenwashing. You know, for example, there was an enforcement action taken against a major financial institution last year for allegedly misrepresenting an investment fund’s green credentials in their marketing materials. So, definitely a lot of scrutiny around greenwashing, that’s for sure.

Rebecca: No, thank you, Sinead. That’s really helpful. You know, as we’ve heard just now from Sinead on the European side where the regulatory agenda is pretty full, to say the least, I think it would be helpful to move across the Atlantic and just get the U.S. perspective. So, Cameron, can you give us an update as to where the SEC stands, and what you see as the outlook for 2023 as it relates to ESG?

SEC & ESG Regulations

Cameron: Yeah, so the SEC has set up really, really ambitious regulatory and policymaking agenda. And I’m not sure that they’re going to make it through all of their rule proposals and all of their proposed rules in 2023, but there are a number of things that touch on ESG that are on their agenda. And just a quick note, the SEC has actually 29 rules in its final stages, and another 23 in proposed stages. So, they have a full plate that is going to be very, very interesting to see how it shakes out and what they actually get through and approve. But of note, as it relates to ESG, there is a proposal that the SEC has, and it’s in its final stages. And it does a couple interesting things that kind of mirrors a lot of what Sinead has just mentioned, so I think that the SEC is taking a similar tact. However, the SEC in its history has always been a disclosure regulator, and so, its new ESG proposal is a disclosure-based requirement.

And let me just walk through a couple of the things that that proposal does. So, first, it essentially says that if you talk the talk, you have to walk the walk. So, if you have a fund and you say that it considers ESG factors, you’re gonna have to provide investors with the information and the prospectus about what ESG factors they consider, and along with the strategies that that fund uses. So, this can include, for example, whether a fund tracks an index, or excludes certain types of investments, or uses a proxy voting strategy to achieve its ESG aims, along with, you know, if it has a particular method by which it seeks to have a specific impact.

The second thing that this proposal does is it establishes a subcategory of ESG funds called an ESG Focused Funds. And these are funds that consider one or more ESG factors by using them as a significant or main consideration in either selling investments…or, sorry, selecting investments, or an engagement of strategy with the companies in which it invests. So, these disclosures would enable investors to dig into the details of a fund strategy.

The third thing that this proposal does is it requires a particular type of ESG Focused Funds to disclose relevant metrics. So, for example, certain funds would be required to report greenhouse gas emissions for their portfolios, and an impact fund would be required to disclose the metrics about annual progress towards its ESG goals.

And the last thing that this proposal does is that it also loops in certain investment advisors who will be required to disclose their ESG strategies, similarly to how investment companies and mutual funds are going to be required to under this rule. So, this basically just loops in private fund advisors who may have private funds that have an ESG focus and subjects them to the same rules that a mutual fund or an ETF provider would also be required to comply with.

So, that’s kind of a quick recap of the SEC’s rulemaking on ESG. And as you can imagine, there’s been a lot of criticism and praise for it. The cost of the proposal is kind of one of the big sticking points for those who oppose it. And then, of course, on the other side, the proponents of it are very adamant that, you know, there’s an investment appetite for this. People want this, it’s worth the cost. So, it’ll be interesting to see how it all shakes out, and I’m looking forward to see how it does in 2023.

ESG Regulations in Asia

Rebecca: And so, Nithi, great to hear what’s been keeping you busy on the ESG front, and what your outlook is for 2023?

Nithi: There’s a lot happening in Asia definitely. I think ESG regulations in Asia has been increasing rapidly, I would say, in the last five years. The heterogeneous nature of the different fund markets in Asia, I must say, has made the adoption of ESG in this part of the world slightly diverse. But the common threat is that ESG is gaining momentum. There is significant awareness and importance given to it, whether it’s in Singapore, Hong Kong, Japan, South Korea, or China. Specifically in Asia, and maybe I’m a little bit biased because I’m sitting in Singapore, I would say Singapore and Hong Kong are leading the way for ESG-focused regulation and change, definitely mirroring a lot of what’s happening in the U.S. and also in Europe.

So, just to touch and give a little bit of information on what’s happening in Singapore, Singapore back in 2020 introduced the environmental risk management guidelines for asset managers. The focus of that particular guideline is on climate change, loss of biodiversity, pollution, changes in land use. The MAS guidelines apply to all discretionary licensed registered fund managers. There is a cover such that it does not apply to non-discretionary asset managers, which I believe is pretty consistent with the take on ESG for other regulators as well, especially in Asia.

Asset managers were required to put in place the right policies, the procedures, the infrastructure to meet the guidelines by June 2022. Of course, the deadline has already passed. So, given that the deadline has already passed, a lot of the asset managers who are now getting audited asked questions specifically around how they have adopted the guidelines, not just in terms of, you know, mere policies, but also looking at how well they have incorporated the requirements into the specific investment construction, the risk management, and also disclosure to the investors.

MAS also did a thematic inspection industry-wide, and they also released something called an information paper. This was done in 2022 to give further guidance to asset managers on exactly how to adopt the guidelines to fit your own size and nature of business. And as recent as 1st of January 2020 through 2023, retail fund managers are now required to disclose investment strategy, matrixes, criteria for retail funds sold with the environmental, social, risk governance label. This is definitely an attempt to tackle greenwashing, which I believe is the right step for us in Asia. And in the horizon in Singapore, I would say MAS is definitely working with the stock exchange, the Singapore Stock Exchange to launch the ESG disclosure platform. It’s called Project Green Print, to allow listed companies to upload corporate sustainability data in a structured and efficient manner.

And just quickly moving on to what we’re seeing in Hong Kong, Hong Kong SFC has taken a similar view on ESG, focusing on climate-related disclosures, risk requirements. Fund manager code of conduct was amended to impose requirements for climate-related risks to be taken into consideration when they’re looking at investment and risk management process. There was a new circular that was also released by the SFC to provide expected standards and examples for asset managers to follow and put in place. Hong Kong also has its Comply-or-Explain ESG reporting requirement for listed companies. So, by and large, Hong Kong and Singapore I would say are pretty consistent in the way they have looked at ESG and how they’ve adopted it into the legislative infrastructure, legislative framework in both countries.

I think what we are seeing in the horizon is that ESG started off with a lot of focus on the E, but definitely as we are progressing, we are seeing a lot more importance given to the S and the G, especially governance, that there is increased emphasis for board of directors, for investment committees, senior managers to have proper delegation of duties, reporting responsibilities, which ties in with the individual accountability. So, there has to be oversight, there has to be proper governance put in place to make sure that appropriate disclosures are given. There is proper matrixes put in place to track and to, you know, make sure that what the companies are saying they’re gonna be doing is exactly done in their practice.

I think that’s pretty much the trend that we’re seeing and what we are seeing definitely in the horizon is definitely more focused on brainwashing, tackling that issue. Singapore and other parts of Asia, the regulators are working together to increase innovation, putting in more money for innovation in this ESG-driven sector. There’s a lot of interest from investors as well where they are more likely to invest in ESG-related, sustainability-related investments as well. So, again, that drives the sector and that drives the demand as well.

Rebecca: Great. Now, thank you, Nithi. I think it’s the focus that a number of the Asian regulators have around governance and board-level oversight, you know, is especially important to highlight. You know, arguably, governance is the most important component of ESG. You know, it’s hard to get traction on the E or the S if you don’t get G right. I’m based in the Cayman Islands, and our team works with managers across the globe who have Cayman funds. Just by way of a brief Cayman update, our regulator, the Cayman Islands Monetary Authority is in the process of developing a suitable regulatory and supervisory approach for climate-related risks and other ESG-related risks. And whilst we don’t know yet what that will look like, it’s worth noting that in CIMA’s April circular, they noted that at a minimum, those charged with governance of regulated funds should have clear roles and responsibilities in managing and mitigating the risks from climate change and other ESG related risks in line with the fund’s set investment objective, and should start establishing reliable approaches for identifying, measuring, and monitoring, and managing material ESG-related risks.

So, there’s a clear expectation from CIMA that it expects Cayman fund boards to overseeing material ESG risks. So, you know, if you think that your board or responsible investing committee could be enhanced by adding an experienced independent director to help you oversee ESG risk compliance or reporting, then we’d be happy to have a follow-up call. So, perhaps moving from governance to presidencies. Nigel, with the UAE taking over the COP presidency this year, what do you expect to see from a regulatory perspective?

ESG Regulations in the UAE

Nigel: Thanks, Rebecca. Yeah. Yes, indeed. The UAE is hosting COP 28 between the 30th of November and 12th of December this year. There are great expectations for COP 28 as it’s the first formal assessment of progress since the Paris Agreement came into force. But hosting COP 28 is just another step on the UAE’s adoption of ESG. It was part of Vision ’21 when the company made great strides in driving sustainability forward in line with the UN’s sustainable development goals. It’s part of Vision 2030, which also highlighted the importance of sustainability. That vision tends to build a sustainable and diversified high-value-added economy that’s well integrated into the global economy, and one that provides more accessible and high-value opportunities for all its citizens and residents. It’s also worth noting that UAE is the first country in the region to adopt a net zero target by 2050.

On the regulatory front, I think it’s fair to say that it’s not as developed as it is in the major markets. It’s still very much at the consultative and voluntary stage. Just going around the various regulators we have in the Abu Dhabi Global market, which is the International Finance Center in Abu Dhabi, it recently unveiled its Sustainable Finance Agenda Declaration at the inaugural Abu Dhabi Sustainable Finance Forum. That declaration acknowledged the UAE’s commitment to addressing climate change and to fostering it and integrating green and sustainable finance in the region.

In Dubai, the DFSA in November ’22 issued a paper on climate and Environmental risk management which contributes to the global debate on how best to address and mitigate the physical and transition risk stemming from climate change, as well as broader environmental risks in the UAE. The Securities and Commodities Authority in the UAE set a master plan to create a more stable and resilient financial system. The key objectives of which are to firstly provide channels for funding of sustainable projects, to encourage corporates and their management to shift towards more effective sustainable practices, to provide investment opportunities and information to investors to invest in sustainable projects, and to create awareness with all market stakeholders on the importance of sustainability and their respective role in supporting it through their actions.

But perhaps the most effective regulator responses come from the ESG disclosure requirements imposed on UAE-listed companies. Well, I say impose. It’s very much voluntary at this stage. It’s not mandatory. But all three main exchanges in the UAE, the Abu Dhabi Securities Exchange, the Dubai Financial Market, and NASDAQ Dubai have deployed key initiatives to promote the adoption of ESG amongst listed companies and investors, including promoting sustainability reporting. ADX, in particular, has established its own ESG disclosure guidance to support its listed issuer sustainability reporting. And that guidance provides listed companies with 31 ESG indicators that are considered essential to report in line with the recommendations of the Sustainable Stock Exchanges Initiative, of which the exchanges here are all members. The indicators are mapped against global reporting initiative indicators and the sustainable development goals for companies willing to adopt more detailed sustainability reporting standards.

Rebecca: Great. Now, thank you for that, Nigel. Could you also perhaps then give us your thoughts on the similarities and differences between ESG investing and the Islamic finance principles?

Similarities & Differences Between ESG Investing and Islamic Finance Principles

Nigel: Excellent question, Rebecca. Yes. I mean, yeah, there’s definitely several parallels between ESG and Islamic finance principles. Clearly, ethical investing is at the core of both frameworks, although the definition of what would be included to be in the scope of ethical investing may differ between each. In very broad terms, Islamic finance requires investment to comply with Sharia law. Broadly, that would involve ensuring investments deal with the protection of faith, life, mind, wealth, and dignity. And it’s not hard to draw the parallels between those concepts and ESG investing. For example, the life goal aligns quite nicely with sustainable finance principles, which emphasize environmental and social protection. There are also parallels bringing the social focus of ESG analysis and integration of the principle of profit and loss sharing, which is central to Islamic finance, because both of them ultimately aim to adopt a shareholder view…a stakeholder view, sorry, and increase social cohesion, and to ensure that nobody is left disenfranchised and left behind.

The methodology adopted for both also has several similarities. Now, both would adopt some kind of exclusionary screening process to filter out opportunities which don’t meet or not consistent with the ideology. Both would consider favorably impact investing and thematic investing in sectors such as education, agriculture, healthcare where it’s most needed. Both would require active ownership of an involvement in assets acquired, not just passive returns generated by interest in dividends. And both have a focus on long-term investing. So, many similarities.

In fact, in a recent research report, ESG investments, which also met Sharia principles, have been found to have ESG scores of 10% higher than those ESG investments which would’ve been viewed as non-Sharia. So, that’s interesting in itself. But just a word of caution, no, they’re not the same. So, while there are similarities, it can’t be assumed that if an investment meets Islamic finance criteria, it would definitely meet ESG criteria or vice versa. For example, ESG may consider an investment in a sustainable financial institution, but that’s unlikely to meet the prohibition of riba under Sharia. And conversely, now there’s significant Islamic investing in the extractive resources industries, which may be unlikely to meet the ESG principles. So, back to you, Rebecca.

Rebecca: Yeah. No, thank you. I really appreciate these insights. You know, moving now to the UK, you know, since Brexit, we’ve obviously seen divergence away from the European regulations. And so, Carwyn, I’d be grateful if you could give us an update as to what the FCA’s priorities are and the outlook for 2023.

ESG Regulations in the UK

Carwyn: Yeah, absolutely, Rebecca. The FCA is typically, you know, historically a first mover when it comes to regulation, but with ESG, it’s stepped back and observed, partly because they’ve seen what complication and confusion SFDR taxonomy regulation has caused in European markets. And they’re fully aware of the challenges around data. But there are a number of different government-led, legislation-led codes that exist already here in the UK, including green finance strategy at the government level and stewardship code. But what I’m gonna focus on today is more about the FCA’s consultation payment issued in October, which is the Sustainability Disclosure Requirements known as SDR, and that’s what I’ll refer to it as for the rest of the conversation, and the investment labels within that consultation paper.

Why are they consulting on it? Reality is the risks that the current wave of ESG, kind of fervent activity brings to the markets and customers is potentially opposed to the FCAs strategic objectives which are protecting consumers and protecting market integrity. So, they’ve stood back and considered carefully what they should put in place in order to align with their own existing regulations, but also work with the operating market as it currently stands in getting firms to disclose appropriately on their product levels and to label their products properly.

So, what essentially is this covering? So, the consultation paper can be broken down into, you know, six essential parts, really. The first part, so for those who are familiar with SFDR, you might think that this piece, which is the investment labels might be closely aligned with Article 6, Article 8, Article 9 of SFDR, but it’s not. So, the first, I guess, category or the first label is a sustainable focus product. This effectively is a product that needs to have at least 70% of the portfolio of that product meeting a credible standard of environmental and/or social sustainability metrics and content, or it aligns with specified, you know, environmental and/or social sustainability metrics as well.

Then you’ve got social improver products. So, these are products that seek to improve the environmental and social sustainability of the assets within those products over time. So, there is some form of effort around those investments to improve their sustainability footprint. And then, finally, you’ve got the sustainable impact products which must have a clear objective to achieve positive and measurable real-world impact on sustainable outcomes through that particular product. So, similar concept, really, in the way that Article 6, 8, and 9 kind of operate, but the labeling, you know, how specific this is, is very different when you consider it, and it’s probably more closely aligned to ESMA’s kind of ongoing consultations about labeling rather than SFDR’s Article 6, 8, and 9.

And then you’ve got consumer-facing disclosures. So, for those who are familiar with, you know, key investor information documents, these are typically a simple, easy-to-read, understandable fact sheet about the investment. The FCA is proposing to have a ESG version effectively of the KID document so that investors can pick up that document, see very quickly what, you know, the features of those products are in terms of key sustainability kind of features and benefits within those products, which is different to SFDR. But you’ve then got the detailed disclosures. So, these are more aligned with the disclosures we’ve seen around the Annex 2 and Annex 3 pre-contractual disclosures. And then you’ve got the Annex 4 and Annex 5 ongoing disclosures.

So, these are, I guess, targeted at a wider audience. The consumer-facing disclosures, I guess, are more directed at retail investors. The detailed disclosures are aimed at the wider markets. So, for more sophisticated retail investors that want to find out a bit more detail, they can, but then the institutional investors can go through the detail in these disclosures, the methodologies that sit behind the nature of the product, and then they can monitor what did the product provider say they would do, and then monitor its performance against that on an ongoing basis. And then later on in a number of years’ time, at least 2025/2026, there is a sustainability entity report which comes out at a manager level.

On top of that, you’ve got naming and marketing rules. So, there is gonna be a prohibition. If you don’t fall into any of the labeling categories, there’ll be a prohibition on using certain terms in your marketing material. So, you can’t go calling your fund a climate impact sustainability, environmental, you know, responsible, net zero, whatever the term might be. You can’t use that term in the name of your product.

There’s also, as well, a requirement that impacts on distributors. So, if you are a distributor of a financial product, so you don’t manufacture this product yourself, you distribute it to a retail environment, you need to make sure that these product labels and the consumer-facing disclosures are fully available and readily available to investors at all time, and that you understand what you’re distributing.

And then finally, there is a general anti-greenwashing rule that’s gonna be applied to all regulated firms regardless. What this is going to do is effectively run alongside and back up and strengthen the ongoing financial promotion rules. And also, FDA’s a principle-based regulator, so principle 7 means that you need to be fair, clear, and not misleading when you’re communicating with your clients. So, this particular anti-green washing rule backs up and gives, you know, I guess, more teeth and more bite to this regulation. Important to be aware considering the global reach of this particular session that overseas funds are not currently considered in this consultation. There’s gonna be further consultation that’s gonna come down the line as well as a consultation on pensions, but right now we’re looking at UK managers, UK funds, and, you know, distribution of those within the UK market.

Timelines, it’s likely that the rules beyond the consultation paper will come into effect 30th of June this year. The anti-greenwashing rule should come into effect at the same time. That’s the proposal. And then the rest of the rules in the SDR should be phased in between 30th of June 2024 and 30th of June 2026.

Rebecca: Great. Thank you, Carwyn. You know, so you’ve spoken a lot about what we can expect from the UK, but I know you’ve also been very busy with a number of non-EU-based managers and UK managers that are marketing into Europe and have European products. Perhaps you could just speak to us a little bit about some of the challenges they’ve faced, and how you’ve been able to address those.

Challenges for Non-EU Based Managers Marketing in Europe

Carwyn: Yeah, absolutely. And I think SFDR is a disclosure regime, and that’s one of the first things that you kind of need to try and get across is that you are, you know, warts and all, disclosing exactly what you intend to do with your investments, you know, your investment approach, you know, particularly with your Article 8 and Article 9 products. The challenge is, is that the disclosure needs to be detailed enough so that investors can understand your approach clearly, they can understand the metrics and, you know, considerations that you have around measuring that. And then you need to disclose on an ongoing basis to prove that you’ve done what you said that you were doing in the initial point.

So, unlike other regulations that I’ve seen, I usually talk to compliance officers or individuals that have got a compliance responsibility about regulatory change. And with SFDR, the challenge has been more about it’s investment people and distribution people that are driving this change because they wanna raise, you know, assets…you know, allocators are looking more and more on Article 8 or Article 9 funds. So, you’re getting the business end chasing the market. Now, there’s always risks when you’ve got a business chasing the market because you don’t put your systems and controls in place to make sure that it operates properly. So, for me, dealing with our clients, it’s making sure that they, first of all, understand the concept of disclosure, they understand the importance of disclosure. Then what I tend to do is to look at the backend, you know, work it from the, you know, back to forwards. What’s in your particular portfolios? Do they qualify to be an Article 8 or an Article 9? So, we pull that apart and consider what’s in there. Can you get data on these guys? So, before you start a project to transition into an, you know, Article 8 or Article 9, first of all, consider, can you do it? And that’s an important thing.

And the penny dropped for a lot of the clients that I’ve spoken to when you put this into the terms that investment managers are familiar with. They’re familiar with the due diligence they undertake on potential investees and portfolio companies in considering return of investment, the credit risks, whether it’s underpriced in the market and the ability to grow. All of these things are things the investment people have done for a long time. But this is now, ESG is a, I guess, it’s another risk class around this, so you’ve gotta factor in ESG consideration and what improvement can you make with these portfolio companies with that in mind. So, ESG isn’t a bolted-on piece in order to meet the SFDR requirements. It has to be embedded in your investment process. The governance around it has to be tight. You have to be making sure that you’re doing what you say that you do, otherwise you’re gonna fall short when you’re doing your annual disclosures. So, that’s the key thing here, is making sure that they understand how this fits into their investment process and they can make it work with the way they currently operate with strength and governance processes around it.

Rebecca: Thank you, Carwyn. Sort of reiterating the points that Cameron made about, you know, walking the talk and obviously, you know, the points that Nithi made around the importance of the governance piece. You know, the European investor push for ESG products, you know, is potentially at odds with the backlash that we’ve seen against ESG from some U.S. investors in certain states. You know, this potentially makes the marketing disclosures quite challenging from U.S. managers who have ESG products or are looking to launch ESG products. You know, Cameron, I’d be really interested to get your view on how managers can navigate these potential challenges in light of the new marketing rule.

How Managers Can Navigate SEC’s New Marketing Rule

Cameron: Yeah, so the SEC’s new marketing rule, which is kind of just a codification of its previous guidance around marketing in general is definitely at play in this ESG context as well, and in greenwashing, and green hushing, as you’ve described. And the important things I think to just kind of keep in mind is that the SEC’s generally fraud, anti-fraud rule still applies in all cases, and that is the primary tool by which the SEC is going to go after greenwashing and go after misleading marketing disclosures. So, there’s also provisions in the marketing rule that give them the authority to kind of take enforcement action against managers and advisors that are engaged in kind of this misleading activity. But they can always fall back on the anti-fraud provisions of the Investment Company Equity Investment Advisors Act to enforce, you know, marketing rules in the absence of anything that’s specifically ESG related.

And, you know, like I think many of the panelists that have kind of mentioned, we’ve seen enforcement in that kind of regard already. Just last year, the SEC brought cases against multiple large firms who said their funds had undergone an ESG quality review, but that was not actually the case. They did the review afterwards, or they did no review at all. They just kind of stuck that label on it and they didn’t do what they were saying they were going to do. And that, you know, as Carwyn mentioned, is primed to open you up for an enforcement action for greenwashing and the like. And I also wanna reiterate what Carwyn said that, yes, you need a framework with a methodology that you can clearly apply and step-by-step walk through your methodology. And this is where it’s really helpful to have an outside firm or help to kind of make sure that you’re staying on the right side of the line in your ESG marketing and your ESG practices, and that you do kind of act consistently with your stated intentions.

Potential Challenges with ESG Provisions

Rebecca: Thank you, Carwyn. And I guess with the new private fund rule, are there any potential challenges you see perhaps with some of the ESG provisions that are often included within side letters?

Cameron: Oh, yeah, absolutely. So, another one of the many rule proposals that are out there from the SEC does govern private funds, and this is one of those kind of interactions where we don’t know if it’s necessarily an intentional interaction between ESG legislation and then the other things that the SEC are doing, but this is where we’re going to see kind of the rules collide and have maybe unintended consequences. But the SEC’s rules related to private funds broadly are prohibiting side letters, and side letters have traditionally been where certain investors can kind of obtain some more ESG concessions from managers. And if side letters are in fact prohibited and those go away, those ESG provisions could clearly be in jeopardy.

And one of the things that is driving kind of the SEC’s push to eliminate side letters is the potential for unintentional but favorable over-disclosure. So, if you have an ESG provision and a side letter that makes the manager do some things that they wouldn’t ordinarily do in order to further an ESG goal, the concern there is does that additional disclosure result in you forcing the manager to disclose something that’s material and non-public. So, there’s some interesting kind of intersections between the way the rules are all going to interact and, you know, it might be one step forward, one step back, but it’s gonna be interesting to see how all these rules when they are finalized and when they do come together how they interact with one another. It’s not clear yet how they may conflict or what the intention is there.

Rebecca: Yeah, it’s gonna be quite challenging for managers to navigate, certainly. You know, perhaps the discussion around side letters is a nice segue into, you know, capital raising in general. Obviously, Nigel, in your region of the world here, you’ve got some very prominent investors who have the ability to write some pretty sizable tickets. What do you see from the investor perspective?

Potential Challenges with ESG Provisions in the UAE

Nigel: Yeah, that’s very interesting what Cameron was saying because I do see that. But, yes, we do have a number of sovereign wealth funds. And whereas as I mentioned before, a lot of the sort of external regulatory effort is at this moment much more of a voluntary guidance and the consultative basis, there’s definitely more specific requirements imposed by investors, both the local SWIFTs and also the external SWIFTs looking to invest in the region through local fund managers.

Let’s deal with the local SWIFTs quickly, first. I mean, we have ADIA, we have Mubadala and others in the UAE, the PIF in Saudi, Mumtalakat in Bahrain, and the Qatar Investment Authority, and all have adopted ESG principles into their investment deployment considerations. For example, ADIA has embedded climate change into its operating processes and requires its investment teams to explore climate change-related opportunities to incorporate climate change impact and risk assessment as part of their investment proposals and due diligence processes, and requires their investment teams to monitor climate change investment practices in their interactions with external managers.

And we see the same principles adopted by external SWIFTs, the EBIDs, the EIBs, the Asia Investment Bank, looking to invest through regional managers into regional opportunities. And just like Cameron said, a lot of those tend to impose requirements on the fund manager of specific ESG-related requirements by side letter, just as Cameron said. So, I’m interested to see how that plays out. But the side letters are very detailed on what needs to be…what they want the fund manager to undertake. They want them, for example, for each potential investment to be assessed as to its environmental climate and social risks, to require the fund manager to secure contractual agreement with each portfolio investment that it will comply with ESG and environment, climate, and social requirements, the obligation on the fund manager to monitor compliance of those portfolio companies’ adherence to those regulations, for the fund manager to institute, you know, internal control procedures around ESG, and to appoint a designated individual to be accountable for it.

So, not just general. They want to be able to point the finger at someone when it goes wrong. And obviously, to report annually on the status of implementation, but with immediate reporting at any kind of social labor, health, or safety incident or accident, which, you know, the fund manager should escalate to its investor because it’s important for ’em to be aware of it. So, that’s immediate reporting, annual reporting in the minimum and immediate reporting of incidents. So, very detailed, much more detailed than I’ve seen anything coming out of the regulator, quite honestly. So, it’s definitely we have got ESG requirements on fund managers, but through an unusual source.

Rebecca: Interesting. And then, Nithi, what are you seeing in Asia?

Potential Challenges with ESG Revisions in the APAC Region

Nithi: What we are seeing here, where I’m sitting, I would say ESG parameters criteria, the importance given to ESG, that’s coming from the larger institutions. So, the pension funds, the, you know, quasi-government bodies who are, you know, allocating funds, they definitely look at ESG as one of the criteria as part of their due diligence when they go out and when they speak to the fund managers. These smaller mid-tier investors, or rather the accredited investors, the private companies, we’re not really seeing that much importance given to ESG just yet. I mean, everybody knows that ESG is important. They do ask some questions around it. They do get the disclosures in their fund-related documents, but I think, you know, they’re still pretty much focused on the returns.

So, I think that kind of translates to the managers. When we speak to the managers, we find that the larger, you know, well-established fund managers, they do place a lot more importance to how they include ESG within the investment, you know, landscape, the investment construction, the way they manage the portfolios, the way they select the investments. There’s so much of importance, and understanding, and work that goes into it. But when we speak to smaller managers, they tend to kind of ask us, you know, “What do we have to do? Is this enough? Can we just put in a policy? How much of this do I have to do?”

So, it’s a little bit difficult. I mean, we are trying to, you know, make sure that, you know, managers are doing the right thing, at the same time they’re not, you know, falling bridge of any regulatory requirements. But I think the fundamental thing that we’re trying to get everybody to do is that ESG is here to stay. It should form part of your investment methodology. It should not be seen as something that you have to do to just tick the box. And I think that is changing, and we will see change given that, you know, governments are putting money into it, they’re just sending the message out, regulators as well. So, we are on the right trend, and I think it’s gonna continue going in that way.

ESG Product Demand in Europe

Rebecca: Thank you, Nithi. And last but not least, I just wanted to bring Sinead back into this discussion. Obviously, you know, a lot of the, you know, ESG product demand has been led by European institutional investors, and with many studies expecting there to be exponential growth in ESG products. You know, is that something that you are seeing in terms of demand in Europe?

Sinead: Yeah, absolutely, Rebecca. In fact, I actually read something last week citing that I think it’s estimated that…I think it’s around 83% of institutional investors in Europe actually plan to increase their allocations to ESG products over the next year alone. So, that’s a staggering figure. So, I think it’s really illustrating kind of that the kind of doing business as usual as others have mentioned it’s no longer really that valid option specifically, you know, in Europe. And that the shift to kind of doing business in a sustainable kind of way, that is really looking like the only way that will secure a company’s trust and financing. So, definitely seeing that European investors are definitely spearheading the demand for ESG products at the moment, that’s for sure.

FCA’s Aimed at Retail Investors

Rebecca: Great. Thanks, Sinead. And if just briefly, Carwyn, you know, a lot of the FCAs seems to be aimed at retail investors. You know, is that a fair statement?

Carwyn: Yeah, I think that’s absolutely spot on there, Rebecca. I think it’s not unsurprising either. I mean, the FCA’s… There’s, well, 55 million adults here in the UK, and the FCA’s core objective is to make sure that those investors are protected, particularly when there’s potential complications and misleading statements and ideologies behind some of these investment products. There’s also, at the moment, a, I guess, what you would call a far-reaching and a cross-cutting piece of regulation called consumer duty, which is focused on how investments are effectively rolled out through, you know, the retail market. What’s going to be important and where we’re gonna be supporting our clients with SDR is how do they run implementation processes for these two, you know, significant pieces of regulations, along with overlap and crossover between consumer duty and SDR. So, it’s important that firms tackle these in parallel and, you know, consider where they crossover, and make sure that they have controls that don’t conflict each other, and they meet both sets of requirements properly.

That said, though, about the retail world, there are parts of SDR which are focused, you know, for institutional investors such as the detailed disclosures, pre-contractual and ongoing reports, as well as the anti-greenwashing rule that covers, you know, all entities and all the products that are in scope. And then there has been some other feedback statements and discussion papers that the FCA have had around capital markets, and debt issuance, and the consideration of ESG matters and risks in things like green bonds. So, the focus absolutely is on the retail customer here, but the FCA does have an eye on the more grown-up markets, let’s say.

3 Key Questions that Managers Should Be Asking Related to ESG

Rebecca: Great. No, thank you. I think one of the things that’s clear from today’s discussion is that we’re not gonna get any global consensus as yet in terms of ESG regulations. You know, there are some kind of key themes around sort of what we see from a marketing and disclosure perspective, but we’re not there in terms of global consensus. And obviously, that makes it challenging for our managers that are operating in multiple jurisdictions and have a global investor base. You know, I appreciate we’ve covered a lot in today’s presentation, but I wanted to leave you with three key questions that managers should be asking as it relates to ESG.

One, do we have the right policies, procedures, and controls in place of both the corporate and product level to mitigate the increased legal and regulatory risk? Two, do we have the right governance and in-house capabilities to oversee ESG risk, or could our border responsible investing committee be enhanced? And three, do we have the right tools and the right data to meet the regulatory and investor reporting requirements?

If the answer to any of these questions is, I’m not sure, then perhaps you could benefit from speaking with one of our ESG experts. We didn’t quite get around the world in 40 minutes, but we did so via Teams, so I’m gonna give us credit for managing climate risk. You know, thanks so much for my panelists today. You know, I really appreciated your insights. And thank you so much for our audience. You know, if you have any queries on anything that’s been covered today, our contact details will appear on the screen shortly, and we’d welcome a follow-up discussion. Thank you again for joining us.