SFDR for Non-EU AIFMs Marketing in EU.

Whilst the dust settled on the first round of implementation, completed in March 2021, uncertainty lingered for a while around the applicability of SFDR for non-EU AIFMs.

Notwithstanding a narrative on its extra-territorial effects, unfolded in the financial industry for a few months since intro

duction of the new rules, the EU Commission has just released its official interpretation, taking a shockingly more conservative approach on the applicability of SFDR for non-EU AIFMs.

Get in touch here with your contacts at Veneziano & Partners to see how we can help with SFDR for Non-EU AIFMs Marketing in EU.

Light Green, Dark Green and not at all Green Products

On top of giving its own unofficial interpretation of the scope of SFDR for non-EU AIFMs, unfortunately a little too loose given the approach now formalised by the EU Commission, the industry has also indulged itself with devising sustainability-related jargon based on different shades of green.

If you are a non-EU AIFMs, familiar with the different national private-placement regimes across Europe, you have most likely stumbled upon the question already, or will in the near future, about what shade of green your financial products are…

This mean that, without getting into the debate on the varying notion of ESG in the US and Europe and now UK – and how high ESG might be on the list of priorities of the new US presidency, it helps to look at the basic and ascertain whether the vision and strategy of a firm take into account ESG already or not.

Most likely, when ESG is taken into account, it amounts to some filters applied in the investment process in order to avoid investments not in line with set environmental or social parameters, or not faring well against certain ESG scores.

And if ESG is not at all taken into account, that’s fine too. Even though that does not exempt the application of certain disclosures under SFDR for non-EU AIFMs marketing in EU.

Once the basics are covered, it makes more sense to start looking at the type of disclosures possibly required under SFDR for non-EU AIFMs, and where these should occur.

Some clarification is warranted though, before we delve further into the subject. From a general perspective, disclosures under SFDR shall be made at different levels and using different media. In other words, disclosures will be required both at the level of the AIFM and its AIF. Also, depending on the level of disclosure required, this will have to be shown on the website of the company, in the pre-contractual documentation used for the offer of the products in the fund’s periodic reporting. And where the industry purported compliance with SFDR for non-EU AIFMs only at product level, with disclosures required only to be integrated in the offering memoranda of their alternative investment funds, on the basis of the official interpretation released by the EU Commission, disclosures will have to be made also on AIFMs websites.

Be clear on the numbers: article -6, -8 and -9 products

Here we look at articles 6, 8 and 9 of SFDR to draw a categorisation of financial products – and thereby ascertain related disclosure requirements

• Not-at-all green: SFDR Article 6 – integration of sustainability risks

This disclosure is required for all financial products and shall be made in the pre-contractual documentation of the AIF, for instance. For products that either promote sustainable characteristic (article 8) or have a sustainable investment objective (article 9) this disclosure is required in addition to specific additional disclosures.

In essence, it is required to describe i) the manner in which the investment decisions take into account and integrate sustainability risks and ii) the results of the assessment of the impact on the returns of financial products potentially of sustainability risks.

AIFMs that don’t take into account ESG, and accordingly do not deem that sustainability risks are relevant, will be required to disclose why that is the case. This will be the only disclosure required where sustainability is not taken into account at all.

• Light green: SFDR article 8 – promotion of environmental or social characteristics 

This additional disclosure shall be made only for AIFs that promote either environmental or social characteristics or a combination of the two.

Before tackling this additional disclosure, it helps to clarify the concept of promoting an environmental or social characteristic within an investment strategy. While this concept has not been officially interpreted yet, there seems to be consensus among European authorities that in this context we are still dealing with strategies with an investment objective that is financial in nature, however, the strategy to obtain the financial objective entails some filtering out of certain investments, for instance, or selecting only certain investments based on assets exclusions, ESG ratings or scores.

In this case, the disclosure required already under article 6 SFDR needs to be integrated with a description of how the promoted characteristics are met. In essence, using the same example of the screening process, here all you want to do is explain the screening process adopted. In cases where a reference benchmark is also indicated, the disclosure shall be integrated with a description of whether and how the index is consistent with the characteristics promoted.

• Dark green: SFDR article 9 – sustainable investments

This additional disclosure shall be made only for AIFs with a sustainable investment objective. In simple terms, a sustainable investment is still an investment in an economic activity, with the crucial addition that it contributes, respectively, to either an environmental or a social objective. In this bracket we may want to include all the investment strategies with an objective of reducing carbon emissions.

Here it is required to describe how the objective will be attained in cases where there is no designated reference index. For cases where an index is instead designated, the disclosure shall contain information to describe how a) the index is aligned with the objective; b) the index differs from a broad market index.

For financial products with objective to reduce carbon emission, this additional disclosure will have to contain a description of how the long-term global warming objectives of the Paris Agreement will be achieved.

Conclusions

The approach adopted by the EU Commission has obviously a set of immediate consequences for the applicability of SFDR for on-EU AIFMs marketing in EU under NPPRs. At the same time, it poses some more long-term questions and inevitable challenges for market participants outside of Europe.

On the one hand, full compliance with SFDR for non-EU AIFMs means that those will also have to make disclosures at entity level on their websites. This will require a bigger effort at the onset. More stakeholders within firms should be involved in the disclosure preparation exercise, given that the related disclosures will look more deeply at how sustainability is integrated in the investment and other internal processes of the firms themselves. For non-EU AIFMs intending to commence marketing under NPPRs in Europe, the lack of sufficient preparation on this exercise – compared to European – and the shortage of appropriate external support might mean longer time to access the EU market with their AIFs.

From a long-term perspective, whilst it is realistic to say that sustainability will be high on the agenda in Europe, the UK and the US, different regimes will develop with different requirements, creating inevitably challenges for. the applicability of SFDR for non-EU AIFMs.

Get in touch here with your contacts at Veneziano & Partners to see how we can help with SFDR for Non-EU AIFMs Marketing in EU.