Financial institutions have a huge role to play to support the transition to a low carbon economy and divert capital towards investments that deliver measurable ESG benefits. In such a challenging context, investments labelled as sustainable have considerably increased in terms of number of products and assets under management. However, for investment to be effective and purposeful, investors must rely on sound product disclosures.
SFDR: hanging the greenwashers out to dry
The EU has adopted a strong regulatory approach shaping disclosure requirements to protect investors against greenwashing. Sustainable Finance Disclosure Regulation (SFDR), first introduced in March 2021 then supplemented by its regulatory technical standards effective in January 2023, aims to bring consistency and comparability to the EU fund industry’s sustainability-related labelling, and provide greater transparency on financial products’ sustainability.
The EU has adopted a strong regulatory approach shaping disclosure requirements to protect investors against greenwashing.
The evolving role of outsourced investment compliance
Increasingly, asset managers have to screen their portfolios to confirm they adhere to the relevant sustainability or ESG criteria as disclosed in the funds’ prospectuses. The investment monitoring process must be enriched with new rules to monitor the additional ESG criteria. For instance, carbon footprint metrics can be monitored at asset and portfolio level to ensure the fund meets its objectives as well as the monitoring of a portfolio’s alignment to the EU taxonomy. Rule cards can be developed to monitor the unique criteria applicable to labels and confirm a fund’s adherence to its benchmark.
It is vital that the investment compliance rules, which underpin sustainability and ESG criteria, are appropriate and regularly monitored. Institutional investors need independent assurance to confirm that the criteria supporting the labels are met, for example, sector exclusions and exclusion of companies involved in prohibited activities.
By relying on third-party independent checks and data sources, asset managers can improve their control framework regarding the adherence to ESG-related investment guidelines and mitigate the risk of greenwashing.
Independent third party monitoring of non-financial processes, controls and data outputs can also help asset managers to build trust with investors and differentiate their products from other asset managers whose products use in-house, or limited, screening processes.
Sustainable and ESG funds are set to grow, and with them, the accompanying regulatory measures to ensure a level playing field and to protect investors from potential mis-selling.
The fast pace in the development of sustainable finance and its regulation makes it difficult for many firms to have in-house teams with the necessary tools required to incorporate sophisticated ESG criteria into their compliance monitoring processes. An outsourced investment compliance provider can offer large teams of compliance specialists as well as the technological capabilities to integrate complex ESG factors into monitoring workflows.
Sustainable and ESG funds are set to grow, and with them, the accompanying regulatory measures to ensure a level playing field and to protect investors from potential mis-selling. Besides the definition of the strategy for sustainable and ESG investing, it is key for asset managers to partner with the right service providers that can contribute in the setup of the right control framework. Being at the centre of the investment funds’ value chain and as data custodian of the fund, asset servicer has the opportunity to play a key role in the delivery of solutions for asset managers in this respect.