Requirements emanating from the EU's Sustainable Finance Disclosure Regulation (SFDR), which are broad in scope, impacting not only asset managers but also other financial market participants including the likes of insurers, pension providers, as well as qualifying venture capital and social entrepreneurship managers. Julian Ide explains the significance of the SFDR
In recent years, the demand for ESG products from investors has grown quite rapidly with no signs of slowing down. Investors increasingly want products that better reflect their values and beliefs, and therefore, have a positive impact on our world, while also delivering sustainable financial returns.
However, the significant growth in investor demand and subsequent response from asset managers has created a crowded environment, which makes it harder for investors to assess ESG credentials of funds and the asset managers who create those products.
The implementation of SFDR will be a game changer, will transform the playing field for the financial industry enabling more transparency and authenticity for clients and will give more sustainable investment choices for investors."
In the effort to overcome these challenges and provide a more transparent landscape, investors will soon see important changes in the way their asset managers provide sustainability related information on their products and updated sustainability policies.
The regulation - with the first set of disclosure required by 10 March 2021 - is part of a much larger framework, which is the EU's action plan on financing sustainable growth, originally adopted in 2018 and has an overall aim to connect finance with sustainability.
What does this mean for the European distribution landscape?
Going forward, any flexible ESG integration approaches are off the table. Analysing sustainability risks as part of the overall risk management framework is integral to building portfolios, which deliver long-term sustainable financial returns. Reporting will be required across the three article categories: funds, which integrate sustainability risks into advice or portfolio management decisions; products, which actively promote environmental or social characteristics, and products, which have sustainable investment as their objective.
According to a study by PwC, 77% of institutional investors will stop purchasing non-ESG products within the next 24 months and by 2025, €7.6trn will be invested in ESG products—that is an increase from 15% today to 57% market share of European assets. Whilst the speed of transition will depend on several factors, including public and political pressure and further regulation, the direction of travel is clear to see.
This means that the industry will not be able to simply highlight in their material that a product is sustainable, they need to show that this has been considered at the outset. Providers will need to disclose information at a firm-level, their sustainability policies and additionally, they will also be required to disclose information on a product-level about their financial products. In both cases, the consideration of principal adverse impacts (PAI) of investment decisions on sustainability factors need to be disclosed.
In addition to the regulatory push, the global pandemic has been a contributing factor towards catapulting and accelerating the world further toward sustainable investing. Both institutional and retail investor interest in ESG continues to grow apace and has arguably accelerated dramatically as a direct result of the ongoing covid-19 crisis. With competition for investor capital expected to ramp up, managers cannot afford to ignore client demands for greater transparency around how they take ESG factors into account.
What does the regulation mean for investors?
The real economy is shifting, and consumers are looking for more sustainable choices. Take the energy sector as an example where renewable energy previously was not available. Now ‘green energy' has become an option that is widely acceptable with providers— energy that has been produced in a sustainable and environmentally friendly manner.
A research study by Franklin Templeton in the UK revealed how strongly younger workplace pensions savers feel about ‘responsible investment'. Up to 78% feel their current pension provision does not align with their values, or do not know if it does. Importantly, 45% of respondents would be motivated to increase their contributions if their pension incorporated responsible investment values.
Investors want their provider to become more motivated in telling investors how they are integrating ESG factors into their business strategies and identifying new products which puts sustainability at the top of their requirements. With the advent of increased sustainability-related disclosures being made available in the public domain, which should be published on websites, this should provide investors with verifiable requirements for sustainability claims.
A gamechanger for the industry
We believe the implementation of SFDR will be a game changer, will transform the playing field for the financial industry enabling more transparency and authenticity for clients and will give more sustainable investment choices for investors. At Franklin Templeton, we don't want to just comply with the regulation - we want to be leaders and do this with integrity.
We believe our business will become an ESG dominated business and we also recognise there is still much to be done. The work required to be fully aligned to the EU's ambitions demands a multi-year effort. We will continue to evolve in this direction, because we believe this is what our clients deserve.
Julian Ide is head of EMEA Distribution at Franklin Templeton