In May this year, the European Commission issued some proposals that would require all asset managers – including those managing private equity and venture capital funds – to explain to prospective investors how sustainability risks are expected to affect returns, to describe how their remuneration policies are consistent with management of these risks, and to publicly disclose their written policy on the integration of sustainability risks in decision-making processes. Related proposals would establish a taxonomy of “sustainable” investments and a low-carbon and positive-carbon impact benchmark.
As we reported at the time, these proposals would represent evolution rather than revolution and, although the asset management industry has issues with some of the detail, the Commission has not challenged the philosophical underpinnings of the model: that managers should respond to the best interests and expressed preferences of their clients (while acting, of course, within the law). Furthermore, many in the private equity sector are already able to demonstrate strong credentials in managing environmental, social and governance risks, and increasingly the market is driving all firms in that direction.
However, the Commission’s original proposals are now going through the EU’s legislative process, and over the summer there were strong indications that some European politicians will try to re-shape them. Most significantly, the European Parliament’s Economic and Monetary Affairs Committee (usually known as ECON) – which will have an important role in shaping these proposals – will formulate its views in the coming months. In the meantime, a draft report issued in August by Paul Tang, the Dutch MEP who has been appointed as rapporteur for this file and who therefore leads the Committee’s work, is concerning. Tang wants to expand the scope of the measures – and, in doing so, challenges the central premise that asset managers should act for the benefit of their beneficiaries. He argues that financial market participants (which would include managers of private funds) should “move beyond a merely financial understanding of their investor duties” and take account of wider societal concerns. Crucially, this shift in duties would apply for all funds, and not only those that profess to invest in a way that is “sustainable.”
Tang insists that all fund managers should establish and publish “due diligence” procedures to “identify, avoid, mitigate, account for and communicate” ESG risks, whether or not those risks will have an economic impact on the returns of the fund. Remuneration rules will also need to be aligned with those procedures, seemingly with 50 percent of performance targets being linked to ESG factors.
These radical suggestions will not go unchallenged, and other members of ECON are known to be against them. Indeed, some even feel that the Commission’s initial proposal went too far, and want to make it clear that sustainability disclosures should only apply where funds are marketed on the basis that they adhere to certain ESG principles. ECON will meet in October to debate these polarized views, before its scheduled final vote in early November. And the European Council – the body representing the European Union’s national governments – will also have its say in due course, and it is expected to take a more pragmatic line.
This is clearly a debate that will continue for some time, and agreement on the package of measures put forward by the Commission is not expected before the European Parliament elections in May 2019. But even if the timetable is long, the pressure for fund managers to take on duties to society at large, as well as their investors, is unlikely to recede.
Simon Witney is special counsel and Patricia Volhard is a partner at Debevoise & Plimpton.
This is part of a series, European Funds Comment, by Debevoise & Plimpton.