ESG Regulation

Global regulators have taken historic measures this year to increase oversight of environmental, social, and governance risks in fund management. The European Commission initiated the 2021 wave of responsible investing regulation by implementing the Sustainable Finance Disclosure Regulation (SFDR) in March. From requiring fund managers to report adverse impacts of investments on the environment or social justice issues to necessitating financial advisors counsel clients about how sustainable their portfolios are, SFDR raises ESG compliance stakes globally by codifying and quantifying sustainability goals and outcomes. The Securities and Exchange Commission could soon take similar measures, given a bombshell announcement from the U.S. Department of Labor (DOL) just last month. The regulator has put forth a proposal that would largely remove barriers that American retirement plan fiduciaries face when considering ESG factors ahead of making investment menu choices and agreeing voting proxies on behalf of plans. Public and private managers are rightfully keeping close watch of the rule as it inches through the approval process, as it will drastically impact the types of funds plans seek and the data-driven questions they get from fiduciaries.

The green wave crashing into compliance departments worldwide represents and inevitable and necessary evolution of the global investment management industry. Countless surveys of retail, institutional, and high-net-worth investors alike across EMEA, North America, and APAC show that the appetite for ESG funds is only growing more veracious. Asset managers’ clients are increasingly defining ESG risk as investment risk – so much so that the phrase has nearly become an industry cliché. However, all investing goals must result in tangible, measurable outcomes, and sustainable investing goals are certainly no exception. Such outcomes simply aren’t achievable without the introduction of legal standards to guide them.

Of course, regulations like SFDR dramatically increase overall reporting demands for EU asset managers’ compliance teams. For instance, funds marketed along ESG lines are required to disclose more information about their investing processes, holdings, and more to the European Supervisory Authorities. While asset managers with scale are struggling to adjust to this new normal, hedge funds, private funds, and smaller investment houses without vast compliance departments may feel stretched even thinner by the requirements of the SFDR standards. For these firms especially, using technology to assist those professionals who are charged with wrangling these new reports is critically important.

In addition to ESG governance and fiduciary solutions, Waystone has developed a digital tool to help managers meet these new challenges: The SFDR Compliance Portal. Using automation specifically designed to ensure managers stay on top of all ESG-related compliance matters, – including disclosures and deadlines, – customizable tools like this portal help firms track all new reporting requirements quickly and in one place.

For those managers with more complex requests – for example, a hedge fund that has 200 portfolio positions, – direct consult with external compliance experts may be optimal for the first rounds of SFDR reporting, especially. Regulatory and governance advisers are neutral third parties who are not interested in dogged philosophical debates around the strength of ESG investing returns. Organizations like Waystone are only interested in doing their jobs: Applying new rules to the ESG status of a particular fund. Regulations like SFDR are regimenting a corner of the investing world that was rife with subjectivity and opinion. Objective eyes are ideal for those managers who already didn’t have the bandwidth to decipher how many of their hedge fund’s 200 positions are in companies that have SFDR-aligned green status and how many do not.

At Waystone, we know that if we are good practitioners in terms of understanding rules and how they apply to the asset managers working with us, we can get the right answer to our clients’ questions about what information they need to disclose to national and supranational regulators. Clarity is what all parties seek when it comes to the complex process of measuring ESG investment risks. For decades, there have been voluntary sustainability standards that managers and investors alike have agreed to meet, such as the Principles for Responsible Investment. But the voluntary nature of these standards has wildly complicated reporting for compliance and other areas of the asset management complex. Meeting increasingly complicated reporting requests that vary on a client-by-client basis challenges asset managers of all sizes, threatening their overall efficiency.

The U.S. managers feeling the immediate effects of SFDR are the giants of the industry. Regardless of where their headquarters sit, multi-national firms that sell funds or provide financial advice to E.U. investors must meet the new reporting demands. This portion of the rule quickens the pace at which the ESG dominos fall, as these massive managers are now calling for the U.S corporations in which they invest to give them the kind of ESG data they need from E.U. companies. This dynamic creates a stronger link between the impacted firms’ investment teams and compliance teams that allows both groups to meet ESG standards.

If passed, the role of the DOL proposal in creating universal ESG regulatory standards will remain indirect – for now. The DOL, of course, is not primary regulator of the investment management industry. However, assets in plans governed by the Employee Retirement Income Security Act of 1974 make up a huge portion of the assets in the investment management world – particularly in the hedge fund and private equity sectors. These funds will get new data questions about how climate change, corporate governance, and workplace factors are assessed in their portfolios from plan sponsors and advisors if the proposal is passed. And because of the lack of specificity in the proposal about what these factors are and how to measure them, the Securities and Exchange Commission may be prompted into rulemaking action. It is clear that new ESG standards will continue to spring up, so managers must be ready to ride the wave for the foreseeable future.