The EU SFDR has missed a trick. Funds can either be sustainable throughout their life (Article 9), promote sustainability characteristics (Article 8) or make no claims of sustainability (Article 6). This leaves little latitude for decarbonisation strategies that acquire high emissions assets with an intention to decarbonise them. Yet many private funds have sufficient influence over their assets to pursue such an impact strategy. Impact funds pursuing this strategy cannot be Article 9 because the assets will not be sustainable at the point of acquisition (and therefore cannot meet the ‘do no significant harm’ criterion), and may not even be Article 8.
This criticism was once levelled against the SFDR in purely hypothetical terms (“what if you’re transitioning a coal power plant to natural gas?”), but more and more private fund managers are bringing such strategies to market. EQT’s Future fund and Eiffel’s debt fund both plan to implement corporate ESG improvements in private companies, for example.
While the EU regulators have taken some steps to accommodate transition strategies within the SFDR, the regulatory position remains murky.
Enter the UK’s FCA. Its draft proposal for a Sustainable Disclosure Regulation addresses this omission. UK domiciled fund managers can apply for one of three labels for a fund: ‘sustainably focused’, ‘improvers’ and ‘impact’. “In the UK, it’s going to be much easier because the idea of transition is expressly recognised with the sustainable improver label,” said Shantanu Naravane, a partner at law firm Herbert Smith Freehills. “It will be easier to design a transition strategy in the UK than it is with the SFDR.”
The SDR applies to all FCA-authorised firms marketing in the UK. But as other jurisdictions – including the US’s SEC develop their own labelling regimes for sustainable funds, a degree of global convergence is possible, said Naravane. The SDR may have started a much wider trend of formally recognising decarbonisation strategies in regulation.
What a shame, then, that the SDR has been delayed yet again. The final version was scheduled for publication by mid-2023; this was later postponed to September and has now been pushed back to the end of the year. Per the initial timeline, it would have come into force from 30 June 2024 for managers with over £50 billion ($63 billion; €58 billion) in AUM and from 30 June 2025 for managers with over £5 billion AUM. It will now likely not come into force until early 2025 for the largest asset managers and 2026 for smaller managers.
The delay encourages managers to stall on bringing their own transition strategies to market. Several UK-based managers “were in the process of designing products earlier this year and had started looking at the FCA’s draft proposals and started thinking about how they should design their products in order to future proof them for the regime that was expected to be coming imminently. And that got delayed to September and now it’s been delayed further to the end of the year”.
But the delay “has also added some uncertainty around whether the final SDR will look similar to the draft proposals that have been published and consulted on”. One of the criticisms the FCA received during the consultation period was that ETFs – to which the proposals also apply – have limited control over their assets and would not be able to meet the stewardship requirements for the proposed labels. To accommodate these concerns, the final version of the labels could look very different.
Without a dedicated regulatory classification for transition strategies, compliance concerns may drive fund managers to shift their future fund plans to less impactful strategies that are better recognised by the regulation.