A leaked letter from the European Commission to two industry trade organisations has suggested a potential delay to the implementation to part of the Sustainable Financial Disclosure Regulation (SFDR).
The rules for Financial Market Participants (FMPs) to make declarations on their websites on how they integrate sustainability considerations – Level 1 – is still expected to come into effect in March 2021. However, a second layer requiring much more detailed disclosures – called the Level 2 Regulatory Technical Standards – is likely to be postponed to the end of the year.
The leaked letter, seen by ESG Clarity, states co-legislators agreed in March 2019 on the “ambitious timeframe” to bring SFDR into force as a “crucial milestone” in identifying “adverse impacts of investment on sustainability”, “ensure credibility of sustainable investments” as well as “increase the awareness of sustainability risks”.
However, the “unprecedented economic and market stress” caused by Covid-19 has led to a delay in the public consultation on the regulation,.
The letter, signed by deputy director general at the EC John Berrigan, said: “Giving stakeholders sufficient time to adequately respond is needed to allow the complex issues contained in the joint consultation paper to be addressed. At the same time, any delays in this consultation do not subtract from the central importance the Regulation has in making the European economy future-proof.”
It later states that most companies are already disclosing sustainability-related risks akin to Level 1 regulation, so the March 2021 deadline remains in place. But Level 2 implementation has been given more leeway.
“In order to provide FMPs and financials advisers as well as supervisors with time for implementation, the Regulatory Technical Standards will become applicable at a later stage,” the letter said.
The EC has not confirmed a delay.
Here, Rodolfo Fracassi, CEO of Main Street Partners, answers ESG Clarity’s questions offering further clarity on the regulation and its delay.
What is this postponement?
The European Commission’s postponement of deadlines for the implementation of Regulation 2088/2019 (SFRD), offers an opportunity to assess the current situation, and why it is important to make the most of the time available to implement the regulation.
The postponement itself is a Pyrrhic victory, in our view, because the European Commission (EC) has agreed to postpone to the end of 2021 the disclosures related to the level 2 of the regulation, but not those of level 1.
In a nutshell, this means there will be some relaxation of the way ESG disclosures should be made in certain areas, but by 10 March 2021 disclosures will still have to be made on policies, risks, compensation and a number of other aspects.
What does this mean for asset managers?
In terms of asset management, from March onwards it will no longer be possible to apply what has become a common practice for different market players regarding ESG valuations: The practice of averaging in order to obtain a fund’s ESG rating.
This approach takes the ESG rating of each holding in the portfolio, averages them and thus obtains the fund’s ESG rating.
While this method may be fast and is certainly economical (because it does not require much more effort than buying a database and pressing a few keys), it does not provide a reliable picture of the sustainability of the portfolio. This requires a holistic and much more thorough approach.
Thankfully, in just a few months’ time, it will be said that this approach is not only not ‘in the spirit’ of the legislation, but contrary to it.
The spirit of the regulation on disclosure is to make public and therefore allow evaluation of much more than solely what is in a portfolio at any one time. ESG policies, ESG risks and a whole range of other qualitative aspects related to the management of the company and the investment strategy, for example.
Do you think ESG ratings go far enough?
Our scepticism around ESG ratings is not helped by the fact that data from the main ESG rating agencies today would suggest a large majority of companies are already sustainable. Take, for example, the EUROSTOXX 50 index. Using an average of the ratings of the main agencies, as many as two-thirds of the companies in the index would be deemed highly sustainable and over 95% seen as sufficiently sustainable.
According to this measure then, the largest companies in Europe by market cap do not have much to improve to further the sustainability agenda, which is patently untrue.
In our minds, this simplistic assessment provides even more motivation to take a more in-depth approach. To make assessments on crucial aspects related to management methods and approaches, as well as to evaluate individual policies and KPIs related to the ESG dimensions of the companies in the portfolio.
How can asset managers use the potential extra the time wisely?
Few players in the market have equipped themselves with the tools and processes to truly evaluate ESG credentials. While we see an important growth trend, as some of the largest asset managers are moving to bring the entire product range to integrate ESG factors into the investment process, it’s going to take a few more months, if not a couple of years for this to really take hold.
Now they have been granted postponement of part of the regulation, there is an opportunity to do things right that should not be missed.