03.10.2021

Asset Managers Face ‘Significant’ SFDR Costs

Asset managers face ‘significant’ compliance costs to adapt to the new EU Sustainable Finance Disclosure rule which starts to take effect from March 10th, a new report published by Bloomberg Intelligence (BI) says.

BI believes costs will mount up due to the need to increase investment in ESG data and expertise which will give an advantage to bigger firms and those which have already adapted such as Mirova.

Asset managers do not have to fully report how they identify and mitigate the effect of their decisions on the environment or society until June 30th, 2023 – but BI warns managers still need to quickly integrate sustainability into decisions and start quarterly disclosures from next year.

EU-based asset managers are well-positioned for the transition, BI believes, but UK-based firms such as Schroders, Standard Life Aberdeen, Martin Currie, and Hermes may struggle due to Brexit divergence and the British Government mandating a variety of disclosure rules.

“The volume and granularity of disclosures could cause compliance challenges for asset managers. In our view they are already struggling to comply with extensive, duplicative disclosures on performance, costs, charges, and risk under PRIIPS and MIFID 2,” said BI Senior Government Analyst Sarah-Jane Mahmud

The BI report, Asset Managers Feel Heat with Sustainability Rule, warns asset managers may struggle to collect the information they need to comply as the quality of company climate and environmental reporting remains poor due to guidelines being advisory.

EU-based asset managers may gain a competitive edge from the rules being introduced given the increasing demand for ESG funds and the performance of the funds in a downturn which could help asset managers’ overall performance, BI says.

The iShares ESG MSCI USA ETF saw the highest flows in the category at over $9 billion in 2020 as North American interest in ESG accelerated. North America overtook Europe in the first half of 2020 indicating that ESG ETFs may be making their way into model portfolios in the US.

Source: Bloomberg Intelligence

Level two SFDR requirements present extreme challenges for asset managers

Charles Sincock, ESG lead at Capco:

“While asset managers may feel broadly comfortable with the initial level one SFDR disclosure requirements (SFDR Article 4) coming into force from Wednesday 10 March, they will now need to reflect on some more onerous challenges that lie ahead around ‘level two’ requirements, notably around data.”

The SFDR data gap

“The level two SFDR reporting requirements due in June 2023 (for the period 2022) have been watered down significantly but nonetheless will still be extremely challenging for asset managers, and it will take time and effort to get things right.

“The regulation initially specified reporting on 34 principal adverse impacts (PAI), but this was reduced to 18 mandatory PAIs and a number of voluntary ones. However, most managers will need to report on more than the core PAIs, considered from a materiality perspective, if they are to provide a full and rounded disclosure, and create a holistic picture of their ESG profile.

“If portfolio investments sit in SFDR Article 8 or 9 categories, claiming ‘social’ or ‘environmental’ credentials, then data will be needed to support these assertions. Managers need to understand what ESG assets are in their portfolio and access data to report on key indicators. Some of this data can be purchased from traditional providers, but much of it doesn’t exist or is certainly not readily accessible in a structured data set. Not only is the data not collected by a provider, it is often not always collected by the underlying company either, effectively making the task of meeting some level two SFDR requirements even more challenging.

“In these circumstances, best efforts will be required and inevitably larger firms will have more operational resource and financial firepower to fuel those efforts. But the level two reporting requirements will be onerous for smaller firms if we do not see the emergence of a consolidated data offering in the industry. Unfortunately, the creation of a one-stop-shop solution is unlikely.

“Whether firms manage the task internally or outsource to third-parties, large scale and high volume data processing – likely drawing upon machine learning and artificial intelligence – will be required to sift through all the available data to come up with informed answers. All this data will also need to be archived and logged for audit and accountability reasons, so cloud technologies may also need to be considered.

“The use of advanced processing techniques such as graph networks can also be used to map the interconnection of data across vast networks and how it drives ESG outcomes and impacts firms’ ESG profiles will need to be considered. Relevant connections, such as companies’ supply chains or business dealings, can be explored to gain insights into how companies behave today and in the past – and the likelihood of them behaving unethically in the future.”

An ESG revolution

“It remains to be seen how reporting requirements for level two of SFDR will play out and what level of ‘best efforts’ will be deemed suitable for asset managers and acceptable to regulators.

“However, SFDR is clearly positive and marks a welcome step change in ESG disclosure. SFDR has significant implications for the ESG strategy of not just asset managers, but across the broader financial services industry. Firms that are genuine about driving ESG change will need to evaluate the holistic impact of their products throughout the financial ecosystem and beyond. They will need data to understand this impact, and SFDR should kick-start the process of meaningfully collecting, measuring and analysing this information.

“Ultimately, the SFDR requirements should encourage wider, corporate level strategic discussions leading to an ESG revolution in financial services. Firms should use this opportunity to consider how they can reflect the principles of SFDR across their whole commercial offering and operating model.”

Source: Capco

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