The events of 2020 led to an increased focus on environmental, social and governance issues within businesses. Infrastructure funds can no longer rely on the notion that ESG is only an issue for public companies. Investors in real asset classes not only want, but need, to show their ESG credentials and compliance as their hands are forced by the introduction and implementation of new regulations for financial markets.
The EU Sustainable Finance Disclosure Regulation – which comes into force today – aims to improve consistency of reporting on sustainability risks. EDHECInfra has welcomed its introduction, which came after the research institute had evaluated various ESG reporting schemes relevant to infrastructure investment. This evaluation showed that the measures in place diverged hugely and that there was a need for consolidation to achieve meaningful comparisons and measure progress. The changes will take effect at an entity and a fund level, with a series of actions required over the next two years.
Since 10 March, entities have been obliged to publish information on their sustainability policies and any assessment of related risks on their investment decisions. They must also disclose the impact of strategic decisions on sustainability – or explain why they do not take such impacts into consideration – and reveal how remuneration policies are consistent with sustainability principles. At the portfolio level, managers must disclose the impact of strategic decisions on sustainability, or explain why they do not take such impacts into consideration. Managers must also explain how funds that claim ESG characteristics or objectives – such as those that invest in renewables – meet those goals. However, this regulation does not just apply to funds marketed as being ESG-compliant. By 30 June 2022, a quantitative report must be published covering 16 ESG metrics and many more additional ‘opt-in’ ESG metrics.
All of the above information must be made public and be published on corporate websites. Originally, these factors consisted of 50 indicators and metrics, including carbon emissions, carbon footprint and deforestation. However, this list was met with complaints from the industry around the perceived difficulties in meeting these reporting requirements, and the supervisory authorities revised the list.
Will it stop ‘greenwashing’?
At first glance, non-EU infrastructure funds could be forgiven for believing they do not fall within the scope of the SFDR and for dismissing regulations as not being relevant to them.
However, this could be a mistake that would expose investors to compliance headaches and reputational risks. As with any aspect of financial services, the implications of this regulation are global. The SFDR applies to entities operating or managing funds in the EU or actively marketing their products in there – even if the entities are headquartered in Asia-Pacific or the US. Many UK-based firms are also likely to remain within the scope of the requirements in their capacity as alternative investment fund managers.
In some parts of the asset management industry, the SFDR has been heralded as a step in addressing ‘greenwashing’. It requires funds that promote ESG characteristics or that claim to have sustainable investment objectives to show how their sustainability goals are being met. Despite this, we anticipate less impact on real asset classes than on retail investment funds. The regulation does not specify that the product-level requirements will apply to legacy funds.
For most infrastructure funds, these types of obligations to their investors are pre-contractual and are not expected to be applied retrospectively to vehicles that have reached final close. However, it is safe to assume that they will be relevant to ongoing reporting, not least because LPs are likely to want clarity on these vehicles’ ESG performance over the fund cycle. It will also become more relevant with the introduction of the EU Taxonomy in 2022, which applies to funds with an express environmental sustainability goal.
Are infra funds prepared?
This regulation requires a step change from the industry in terms of transparency and reporting related to ESG criteria, and the industry is falling way behind the curve.
Infrastructure funds first need to understand whether they fall within the scope of SFDR obligations at entity and fund level, especially if they retain a presence in the EU or have EU-based LPs. It will also be necessary to assess which of the SFDR’s product categories will apply to current, existing and upcoming funds.
It is not a trivial task for infrastructure investors, with the collection of correct and accurate data the most daunting issue. Although funds are experienced in obtaining financial performance data from their portfolio and underlying assets, the type and breadth of ESG data needed to comply with this regulation poses a new challenge. Once the relevant data are obtained, funds will need to address the potential inconsistencies in approaches to data collection, data quality and accuracy between portfolio assets.
ESG regulation will remain a priority for market participants in 2021 and beyond. The SFDR presents a new and potentially daunting challenge for those finding themselves within its scope. However, it is only the beginning of ESG regulation for financial markets globally.
Non-EU infrastructure funds should see this as an opportunity to get ahead of the game and ensure they can collect and analyse relevant ESG data before the inevitable introduction of new regulations in their domestic markets. Compliance, whether mandatory or voluntary, should be seen as a business enabler – certainly with regard to sustainability and climate change.
In that sense, proactively integrating these risks into internal operations and disclosures may be the difference between gaining investment capital or losing it in a highly competitive market.
Andy Pitts-Tucker is head of Apex Group’s ESG ratings and advisory team, founder of PT Conversation and a development board member at Tusk Trust