Impact in Focus Ahead of ESMA Deadline

Asset managers expected to look to UK guidance to fill gaps as new thresholds come into force for SFDR-registered vehicles.  

With more than 1,000 EU-domiciled green funds expected to change names over the next couple of months, investment managers are taking different views on assessing and attributing impact. 

A lack of clear guidance for funds marketed in Europe could see a steep – but temporary – decline in the coming weeks in the number of funds marketed as providing impact.  

While the UK has adopted specific requirements for how investor impact can be achieved and measured by funds marketed under a ‘Sustainability Impact’ label, guidelines from the European Securities and Markets Authority (ESMA), published last year, have left this to one side for now. 

New EU funds have had to comply with these guidelines since last November, while existing funds have until 21 May to consider whether they need to change their name. 

These guidelines are an attempt to limit greenwashing in Europe by ensuring the names of funds claiming positive sustainability-related outcomes accurately reflected their investment strategies, partly by imposing minimum thresholds on funds with specific sustainability-related terms in their titles.   

The ESMA guidelines are expected to serve as a stopgap measure ahead of a more expansive and far-reaching update to the Sustainable Finance Disclosure Regulation (SFDR) that will be put forward later this year. 

The experience of funds over the next few months could shape the discussion about whether a more precise impact label needs to be included in the EU’s revised rules.  

Funds data and analytics provider Morningstar Sustainalytics predicts that between 30% and 50% of in-scope funds will change name as a result of ESMA’s new guidelines. This could capture as many as 1,200 funds. 

Hortense Bioy, Head of Sustainable Investing at Morningstar Sustainalytics, told ESG Investor that most of these name changes will take place over the next month. 

“When I spoke to managers in January, many of them were not ready to change the names yet. They hadn’t sent the prospectuses to investors,” said Bioy. “Now they probably know what they are going to do, and will have only a few weeks to send their prospectuses to investors. They won’t want to leave things until the very last minute.” 

Making an impact 

Since there are no specific criteria for defining what ‘impact’ means within the context of SFDR – which was originally intended as disclosure rather than a categorisation regime – many funds have to use their own internal classification. 

“SDG [UN Sustainable Development Goals] funds could be considered as impact funds, even though in reality they only have to meet sustainability criteria,” said Bioy. “Many SDG funds may have been marketed as impact funds even though they don’t use that word.” 

In the absence of specific guidance, some of the more sustainability conscious funds are falling back on the UK’s definition of impact investing as part of its Sustainability Disclosure Requirements (SDR) and investment labels regime. 

Jamie Broderick, Deputy Chair of the UK’s not-profit Impact Investing Institute, says that this should come as no surprise. 

“It makes sense for these funds to use the more rigorous standard, because then they can use it for both SDR and SFDR,” said Broderick. 

The SDR requires funds that carry the Sustainability Impact label to have an objective “consistent with an aim to achieve a pre-defined positive measurable impact”. Managers must also specify a theory of change on how they expect to achieve impact, as well as a robust method for demonstrating and measuring impact, both of the invested assets and their investment activities.  

“It is not sufficient to just invest in a group of companies that are creating impact. Fund managers also have to explain how the investor contribution is leading to this impact,” said Broderick. 

Often referred to as ‘investor additionality’, it is this concept that many investors have struggled to get comfortable with. 

“We are looking at things through a UK lens,” said Deepshika Hariparsad, Product Director at global investment manager Ninety One. “When it comes to impact investing or sustainable investing, the EU is using the taxonomy as the highest bar, but there haven’t been any conversations, to the best of my knowledge, about investor additionality being a requirement.” 

Ninety One manages both SDR funds, under the UK’s rules, and SFDR-registered funds. 

Hariparsad said the lack of clarity on European plans has caused difficulties for her team. 

“Rather unfortunately this has been a moving goal post,” she said. “There are so many external factors that require interpretation before you even get to having a minimum level of sustainable investments in your fund. Whenever the interpretations change, or whenever new information becomes available, we have had to look again at our investment strategy and whether the current thesis holds.” 

Principles versus rules 

A key distinction with the UK’s framework is that it is more principles-based and less rules-based than the EU’s labelling regime. 

The Financial Conduct Authority (FCA) interprets investor impact using a set of four core principles initially developed by the Impact Management Platform: signalling a commitment to impact, growing in new or undersupplied markets, providing flexible capital and engaging with other investees or stakeholders. 

“Some of these, such as signalling and engagement, are hard to quantify, but as long as fund managers can demonstrate that they are doing something that is more rigorous and more distinctive than run-of-the-mill stewardship, the FCA sees this as a credible route to impact,” said Broderick. 

Karen Shackleton, Chair and Founder of Pensions for Purpose, which advises asset owners on impact strategies, says that the principles-based nature of the FCA rules is a positive for British pension funds. 

“The asset owner is much more interested in what the fund is doing rather than how it is doing it: does this strategy align to its goals, its priorities, its investment beliefs?” said Shackleton. 

Although a European Commission (EC) consultation reflected a lack of consensus on how to revise SFDR, DG FISMA has indicated its new iteration will introduce formal categories with clearer criteria. While the European Supervisory Authorities initially proposed two new categories, consensus has shifted to three, focused on sustainability, transition and impact.  

According to the EC’s recent work programme, the SFDR review will take place in the fourth quarter, giving it time to consider how the new regime provides guidance on impact investing before unleashing new rules upon Europe’s investment management community. 

“They could just look at the SDR rules and see what they have done, because I think they have thought about this quite intelligently,” said Shackleton. 

 

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