Failing to comply with upcoming sustainable European Union (EU) finance regulations could negatively influence the ability of fund managers to raise capital across the continent, argues IQ-EQ’s client director, Francesco Cavallini.
Speaking to Fundeye, Mr Cavallini explained that investors will be less likely to allocate resources towards strategies not constructively engaging in environmental, social and governance (ESG) issues. This includes meeting the reporting requirements of the sustainable finance disclosure regulations (SFDR), which are set to come into effect across the EU on 10 March.
He said: “I see the risk of not complying with SFDR more on the side of capital raising. I believe that in the future, a fund manager that does not comply with SFDR at all is at risk of not successfully raising capital as it would have in the past.”
SFDR aims to provide more transparency on sustainability within the financial markets in a standardised way. The intention is to prevent greenwashing while ensuring comparability This is a particularly prominent issue following the explosion in ESG strategies announced during the global pandemic across the investment industry.
It remains unlikely that sanctions will be imposed by the regulators at this current rollout stage, with the focus instead being on responsibility and good practice when it comes to reporting ESG information.
Nevertheless, Mr Cavallini felt that fund managers needed to take into account that younger investors were much more focused on sustainability issues and that reporting obligations were only likely to become more prominent in the future.
Commenting on the rapid increase in ESG strategies and the socially conscious outlook of younger investors, the client director said: “We see a lot of institutional investors today actively looking for ESG due diligence and for sustainability in their portfolio. This trend will grow, especially when you look at the next generation of fund managers and next generation of limited partners. The younger generation are much more interested in looking into sustainability and ESG, broadly speaking and will push for transparency.”
The regulations around reporting disclosures are likely to remain very broad during the initial phase, with a lot of breathing room for participants to do report how they think is best. This would provide asset managers with the benefit of flexibility, even with the looming deadline.
Mr Cavallini added: “It's going to be each financial market participant's responsibility to be transparent. That’s the ultimate goal of SFDR, to build transparency. How far investment managers will take SFDR will depend on their investment strategies and on their LP requirements.”
Nevertheless, there were challenges with this flexible approach. Due to the instability and volatility of the global Covid-19 pandemic, it was still unclear whether smaller fund managers and non-ESG strategies would have to commit to the same level of disclosures.
Sarmad Naim, associate director within IQ-EQ’s regulatory team, believed that it lacked the specificity of previous regulatory movements which could potentially lead to disruption and confusion if not rectified.
He told Fundeye: “With AIFMD, there was a clear distinction between small fund managers and large fund managers. For smaller fund managers, there were much fewer requirements. That distinction is still sort of ambiguous on SFDR, and small fund managers are still looking for some guidance from the regulators on this.”
Mr Naim also touched on Brexit, and how this would affect UK investors, strategists and fund managers. While UK-based products were not directly affected by SFDR’s implementation, it would be necessary for all funds looking to raise capital within the European bloc to comply with them.
He explained: “UK funds will be caught by SFDR if they do have European investors on board. Otherwise, they are not required to cater for it unless the UK creates something similar. But, if any of the UK fund managers are looking to raise European capital in the future, then they should be looking into complying with this, and probably opt in at times.”
It remains unclear whether the UK will seek to diverge from the EU on reporting. Alignments and deviations between the UK and EU on financial regulations are likely to continue over the short and medium term, however the UK has a strong record on sustainability and green finance, while it is highly likely UK fund managers will continue to do business in the EU.
Outlining this reality, Mr Cavallini said: “I don't think that the UK can afford to do nothing, because the UK will continue to raise capital in Europe. Given that other major countries are implementing similar regulations, I think that at some point, they will join the effort in one way or the other.”
