Key takeaways
If you are an asset manager or wealth advisor, you likely have pondered the question of sustainable investments once or twice - especially if you are seeking a sustainability profile for your products.
The concept of “sustainable investment" can be found in the Sustainable Finance Disclosure Regulation (SFDR) texts and the sustainability preferences under MiFID II. And, turns out, it is one of the greatest pending question marks regarding both these sustainable finance regulations.
The SFDR qualifies sustainable investment as the following:
‘Sustainable investment’ means an investment in an economic activity that contributes to an environmental objective, as measured, for example, by key resource efficiency indicators on the use of energy, renewable energy, raw materials, water, and land, on the production of waste, and greenhouse gas emissions, or on its impact on biodiversity and the circular economy, or an investment in an economic activity that contributes to a social objective, in particular an investment that contributes to tackling inequality or that fosters social cohesion, social integration, and labor relations, or an investment in human capital or economically or socially disadvantaged communities, provided that such investments do not significantly harm any of those objectives and that the investee companies follow good governance practices, in particular with respect to sound management structures, employee relations, remuneration of staff and tax compliance. - SFDR, Article 2
As you can see, the conjunction “or” appears six times in this paragraph (we counted!). It shows how much room for interpretation SFDR leaves.
From regulatory texts to actions
The above definition might not give the clearest idea of what qualifies as a sustainable investment under the SFDR. Dissecting it, one can sum up a sustainable investment as one that fulfills the three following criteria of the investment and investee company:
- Contribution to an environmental or social objective - i.e. there needs to be a clear positive contribution to a sustainable objective;
- “Do no significant harm” (DNSH) - meaning that while maintaining a clear positive contribution, the investment should not cause harm on any other objective;
- Good governance - all while, there need to be good governance practices in place in the investee companies.
Different from other EU regulations regarding sustainable investments (for example, the EU Taxonomy), this is where the criteria end. It is now time for each fund and asset manager to address this list of criteria in the investment process using their own judgment. In other words: they need to set their own definitions, further criteria, and thresholds for contribution, DNSH, and good governance.
Some helpful advice has been provided in Q&As and clarification documents of the EU Supervisory Authorities (ESAs) on how to assess the aspects of sustainable investments, for example by clarifying that Principal Adverse Impact (PAI) indicators are to be used in the assessment. Aside from that, the regulation leaves a lot to wish for in terms of guidance on how to assess sustainable investments.
Why is the definition of "Sustainable Investments" relevant under EU regulations?
Under the delegated regulation of SFDR, also referred to as the Regulatory Technical Standard (RTS), Articles 8 and 9 products must disclose their intention of the minimum proportion of sustainable investments in the pre-contractual documents, as well as include the actual proportion in the periodic reporting. In addition, investors also need to include descriptions of the criteria they have set for sustainable investments, in terms of what constitutes a contribution, thresholds for DNSH, and criteria for good governance.
In addition to this, financial advisors have since, August 2nd, 2022, been required to ask about and accommodate clients' sustainability preferences under MiFID II, including the proportion of sustainable investments. Therefore, setting the definition of sustainable investments is crucial to allow your funds to be identified by advisors as relevant products for their clients.
The future of sustainable investments in the EU
It is certain that investors, asset managers, and advisors will continue to need information about the sustainability profile of investments. And upholding certain criteria of what can qualify as sustainable will continue to be important. The need for regulatory support, in this case, stems from two different pressures: to relieve the market from misleading and unsubstantiated sustainability claims, as well as to provide more understandable information on the sustainability profile of a financial product for the buyer.
The taxonomy is currently in place, however with a small scope and in the early stages which limits the option to restrict usage to taxonomy-aligned activities as sustainable for fund managers. So far, criteria for sustainable investments that are not taxonomy-aligned have been kept vague by the regulators with the approach to allow a certain degree of “freedom under transparency” from fund and asset managers, still leaving some of the aforementioned problems unsolved.
There might also be hopes for the definition to be somewhat harmonized by the market itself, however fear of greenwashing claims might block this. The ESAs have, since the early stages of the regulation, tried to address these issues through clarifications of the criteria, and recently announced a public consultation on proposed changes to the RTS, including a much-needed refinement of the DNSH disclosure criteria.
How Datia can help
Datia offers both data and software solutions for asset managers and wealth advisors to effectively assess sustainable investments.
Datia’s platform solves two challenges: first, in a step-by-step approach, it enables asset managers to create their methodology, choosing different indicators and setting thresholds; second, it allows asset managers to immediately evaluate what proportion of their portfolio is meeting their own criteria.
Read more about Datia's Sustainable Investments Screening solution.
