For US fund managers, the EU’s new ESG regulations place trillions of dollars on the line.
That’s how much, in assets, these managers have in funds actively marketed in the EU; to put it in perspective, a third of the 100 largest cross-border investment managers with funds being distributed into Europe have a US parent company. And every fund, even if it doesn’t market itself as sustainable, will now have to abide by Europe’s sweeping Sustainable Finance Disclosure Regulation regime, which came into effect in March.
Challenges abound: How to make sense of the jargon-filled regulations and local taxonomies? How to understand what local investors want? Where to start when crafting and communicating ESG policies, working with data agencies, and reporting impact? And how to do it all when, as Marie-Adelaide de Nicolay, head of the Brussels office of the Alternative Investment Management Association, told The Wall Street Journal, the new rules are “going much further than [firms’ current reporting] because we don’t have the data”?
The road ahead may seem daunting – but there are actions US fund managers can take to make the process of meeting these requirements easier. Here’s how they can get started.
Understand how you stack up
European investors will increasingly seek out funds that meet a range of new ESG-related standards, forcing fund managers to become familiar with their intricacies. Some will only invest in Article 8 or 9 funds, as defined by the SFDR. Some will only invest in those that have signed on to the United Nations’ Principals for Responsible Investing. And others will see if managers are meeting certain disclosure requirements, or applying other common frameworks, like those put out by the Sustainability Accounting Standards Board or Global Reporting Initiative.
These standards are complex and, in some cases, fast-evolving. For instance, there is limited guidance around what qualifies as an Article 8 – or an ‘environmental and socially promoting’ – fund. One way would be to adopt the SDFR’s principal adverse sustainability indicators. But doing so doesn’t immediately qualify the fund – managers must also integrate these indicators into their investment decisions.
Familiarising yourself with the ins and outs of these definitions is the first step towards labelling your fund appropriately and supporting the rationale for that classification. From there, managers should identify their needs and work backwards to provide the substance investors and regulators in Europe and the US require. If not, they risk claims of greenwashing or inappropriate classification.
Ultimately, understanding these standards and frameworks can help US managers adopt a holistic, future-proof ESG strategy as regulations and disclosures continue to increase. For instance, it won’t be efficient to adopt one framework now and then another and another; rather, fund managers could utilise multiple frameworks – like those put out by the Task Force on Climate-Related Disclosures, the UN’s Sustainable Development Goals, or PRI reporting – and combine it with their own ESG metrics.
Bridge the data gap
Most fund managers will use data rating agencies, often alongside their own mechanisms, to ascertain the ESG information they need to make investing, reporting and measurement decisions. But, as noted above, funds often don’t have the data those agencies need to provide the information new EU regulations demand.
Take US fund manager Barings: according to The Wall Street Journal, its Ireland-based Global High Yield Credit Strategies Fund has a stake in Inspire Brands, which owns Dunkin’, Arby’s, and other American restaurant chains. Since Inspire is privately owned, it doesn’t disclose most of the metrics that Barings must now disclose, like the gender pay gap.
US private equity funds are particularly challenged in this respect. Where public companies and traditional funds have regular and extensive reporting requirements, PE firms disclose much less. According to a study by Institutional Investor, of the 431 PE firms that directly invest and commit to PRI’s six principles, less than one in eight publicly disclose that they receive ESG reports from their portfolio companies, and only 16 share whether ESG issues impact financial performance.
US private equity fund managers need to bridge the data gap by working with data agencies to meet the requisite criteria. That could mean engaging a consultancy to understand these agencies’ methods and processes, crafting bespoke ESG policies specific to a particular company or fund, or analyzing ratings with the investments they’re already exposed to. It could also entail a cultural change that would encourage private equity firms’ boards to review their own ESG frameworks and deliver a report to the fund manager and any external boards. In Europe, some firms offer assurance engagements that could be used to review these reports independently.
Start simple – but start somewhere
Don’t be stymied by the immensity of the task or perfectionist impulses. That could be a disservice to what you’re already doing, which could be woven into an ESG policy. For instance, maybe your CEO volunteers once a month at an under-resourced school. Or you’re beginning to apply certain frameworks or working towards certain sustainable development goals.
Some may fear being called out for greenwashing. The SEC and others have also heightened pressure around making sure ESG funds are putting the necessary resources behind their efforts. But as long as managers are clear about where they’re at and taking proportionate, appropriate, and relevant actions, they should have no qualms about getting started.
After all, doing something is better than doing nothing. Not only will making a start lay the groundwork for meeting mounting ESG requirements, but those who credibly adopt the EU taxonomy’s objectives have the potential to be more successful fundraising – for they can deliver the products and services needed to encourage ESG investing.
Victoria Gillespie is responsible for JTC’s ESG Services and is based in London. She joined JTC following the acquisition of INDOS Financial