Management and sustainability risk: are you ready?

Introduction

 On 21 April 2021 the European Commission adopted:

• a new Delegated Directive (EU) 2021/1270 amending Directive 2010/43/EU (the “UCITS Delegated Directive”), as regards sustainability risks and sustainability factors for undertakings for collective investment in transferable securities (“UCITS”); and
• a new Delegated Regulation (EU) 2021/1255 amending Delegated Regulation (EU) No 231/2013 (the “AIFMR”), as regards sustainability risks and sustainability factors to be taken into account by alternative investment fund managers (“AIFMs”).

Specifically, it impacts management companies and AIFMs and how they integrate sustainability risks in their management process.

For a definition of “sustainability risks” and other ESG-related industry terms, please refer to our ESG Glossary.

Background: what was required so far?

 Under Article 3 of the Regulation (EU) 2019/2088 on sustainability-related disclosures (“SFDR”), financial market participants – in our case, management companies and AIFMs – must publish on their website “information about their policies on the integration of sustainability risks in their investment decision‐making process”. In some cases, management companies and AIFMs opted for simply disclosing that they would not integrate sustainability risks in their investment decision-making process.

What are the new requirements?

The UCITS Delegated Directive and the AIFMR go one step further as management companies and AIFMs are now required – in accordance with the proportionality principle – to take into account sustainability risks when establishing, implementing and maintaining their internal procedures and organisation. This is regardless of whether these are offering sustainable funds or not. With this in mind, there is also an obligation for management companies and AIFM to ensure sufficient resources and expertise for effectively integrating sustainability risks in their processes.

The responsibility for integrating sustainability risks in the firm’s activities will lay with senior management. This means ensuring that sustainability risks are integrated when:

• implementing the investment policy for each managed fund and overseeing the approval of such investment strategies;
• ensuring that it has a permanent and effective compliance function;
• reviewing periodically that the general investment policy, the investment strategies and the risk limits of each managed fund are properly and effectively implemented and complied with;
• approving and reviewing periodically the adequacy of the internal procedures for undertaking investment decisions for each managed fund;
• approving and reviewing periodically the risk management policy and arrangements, processes and techniques for implementing that policy; and
• for AIFM, ensuring that valuation procedures are well designed and implemented.

Sustainability risks should also be considered when identifying potential conflicts of interest or when performing due diligence on investments or implementing the risk management policy as regards the portfolio composition of a specific fund.

Sustainability risks must now be considered alongside the traditional market, liquidity, and counterparty risks.

What does it mean in practice?

 When implementing the new requirements under the UCITS Delegated Directive and/or the AIFMR, you should pay particular attention to the following:

• the website disclosures under Article 3 SFDR;
• the product pre-contractual disclosures under Article 6 SFDR; and
• all relevant policies and procedures relating to:
  • investment due diligence;
  • risk management;
  • remuneration;
  • recruitments and human resources (including a sufficient panel of expertise and regular trainings on sustainability-related matters);
  • organisational structure and decision-making;
  • internal reporting and recording keeping; conflict of interest;
  • delegation monitoring; accounting and valuation;
  • costs and fees;
  • reporting; and internal control functions and regular controls by senior management.

 Entry into force

For management companies, the deadline for transposition by Member States is 31 July 2022, for the measures to apply from 1 August 2022. You can follow transposition in each Member State here.

For AIFMs, the measures will apply directly from 1 August 2022.

In conclusion

Sustainability risks have the potential to really impact funds, and as such should be taken into account by management companies and AIFMs at several levels, regardless of whether these are offering sustainable funds or not.

With the deadline for implementation upon us, management companies and AIFMs should review their internal procedures and processes as well as their risk management policies, whilst at the same time ensuring that they have sufficient capabilities and expertise to perform this review and continuous monitoring effectively.

Finally, they should ensure that disclosures previously made under Article 3 and/or Article 6 SFDR are still accurate after having reviewed those procedures and processes to integrate sustainability risks as well as a review of the delegation arrangements.

If you have any further specific questions or queries in this regard or require support in implementing the above, do not hesitate to reach out to our team.