If You Ignore These Two Fund Regulations You Might Never Make Money Again

In the past 18 months, two European Union regulations relating to sustainable finance have been sending tremors through the global investment community. While the sector grapples to understand them fully, they will create a starker contrast between those fund managers and investors who consider sustainability and those who don’t. What is most unnerving is that, without the right advice, the future implications of which side of the line they fall are still unclear.

“How ESG is factored into investors’ decision-making is a live topic at the moment,” said EVORA Executive Director and co-founder Paul Sutcliffe, whose firm provides sustainable real asset investment and finance consultancy and ESG software. “There’s a spectrum to how the industry is reacting — some want to push sustainability further while those who lag behind need to be encouraged by regulation. There’s also a worry that there will be a real first-mover disadvantage and this is, in some areas, causing a delay in progress. Some industry participants are holding back on progression because they fear criticism and developing approaches that become obsolete quickly.”

The Regulations

The first piece of legislation is the Sustainable Finance Disclosure Regulation, introduced in March 2021. This imposes mandatory ESG disclosure obligations on fund managers and those raising capital in the European Union. Under the regulations, funds will be labelled either six for a lesser focus on sustainability, or eight or nine for a stronger focus.

“The SFDR is forcing investors to decide how to position their product, and to choose whether to state sustainable objectives in the same way as financial objectives,” Sutcliffe said. “They’re having to make an active decision on whether to factor sustainability into funds thoroughly or stick to a light touch. The general concern is that if a product is labelled only article 6, then the fund manager’s ability to raise capital will be restricted. A similar approach has been forewarned by the UK’s FCA.”

The second set of regulations is the EU Taxonomy, which is a green labelling system for financial products that was introduced in June 2020. The trickiness, particularly in terms of real estate financial products, is that the definitions given require improvement, Sutcliffe said.

“The concept of the Taxonomy is wonderful, trying to standardise what’s green and not green, but it needs further work,” he said. “For example, A-rated EPCs are classed as taxonomy aligned, but several EU countries don’t use an alphabetical A-G rating system. No one knows how to work with it. The EU is due to provide further clarity through level 2 regulations but these are still only in draft form.”

Without a full understanding, Sutcliffe reported that fund managers are extremely concerned about how to pitch a product in ESG terms. Acceptable standards for Article 8 and 9 alignment remain unclear.

Don't Wait On This

The pressure on fund managers to state their position is only set to increase. ESG commitments have been increasingly factored into the approach of investment managers. Members of the UN-Convened New-Zero Asset Owner Alliance, who collectively manage $6.6 trillion in assets, have committed to transition their portfolios to net-zero carbon by 2050.

EVORA Chief Strategy Officer Sonny Masero highlighted how ESG funds now account for 36% of the market.

“If you don’t have an answer to ESG, you’re cutting yourselves out of capital,” he said. “We’re seeing a significant change from ESG being the remit of a small team to now being the responsibility of every fund manager.”

In some ways, fund managers have now been given a second job: to make sustainability decisions as well as financial decisions. And while the tools to make financial decisions remain the same, there is still a lack of tools and data to help make ESG decisions. Masero highlighted how there are lots of indices to benchmark financial performance, but for real estate there’s no ESG benchmark on an asset level.

“Without many tools, we’re helping clients to look closely at investment mandates,” he said. “What are investors asking of asset managers? How clearly are they stating their ESG requirements? What do asset managers need to report back?”

EVORA has been receiving an increasing number of calls from clients looking to understand how to factor the new regulations into decisions. Sutcliffe said that the firm is now working with debt funds for the first time, many of which are now looking to establish sustainability-linked debt products.

“All fund managers have to find a route through, which is what we are advising on,” he said. “I do believe that those who put forward clear communications about their commitments will have an advantage. We would encourage all our clients to move forward with this.”

Sutcliffe and Masero are confident that the application and remit of the regulations will become clearer over time, particularly as ESG priorities become more prominent. EVORA is currently running a survey of how ESG data is used in decision-making, particularly in light of these regulations.

However, they are also sure that those fund managers who do not act now, even though it is unclear, will struggle. The market is changing fast and those that do not move closer to sustainability with it could miss out.

This article was produced in collaboration between EVORA Global and Studio B. Bisnow news staff was not involved in the production of this content.

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