The challenging path to an ESG fund

ESG – a subject that has been inescapable for some time. And the path of becoming an ESG-compliant fund in terms of Art.8 and 9 SFDR has certainly been no walk in the park.

ESG stands for ‘Environmental’, ‘Social’ and ‘(good) Governance’ and implies that financial products are no longer just about economic profits.

The first main part of the ESG regulations - SFDR Level I – already entered into force two years ago on 10 March 2021, laying the foundations for classifying all products into three categories: ‘Art. 6’, ‘Art. 8’ and ‘Art. 9’. And a lot has happened since then…

Underestimated at the start and perceived in the worst case as purely a marketing tool, the regulation has developed over the last 24 months into one of the greatest changes for asset managers and management companies in recent history. After Level I, the Taxonomy Regulation entered into force in 2022, followed by changes in key guidelines and directives relating to UCITS and AIFs, changes in the MIFID Directive and ultimately the heart of the regulation: Level II SFDR, including the corresponding technical standards that entered into force at the beginning of 2023.

And there was one objective above all for the European institutions here: ensuring transparency and standardised mandatory publications in relation to sustainability in order to allow investors to understand ‘green’ products, evaluate them in qualitative and quantitative terms and compare them to one another. The regulation was also intended to further advance the monitoring and review of the subject by supervisory authorities and auditors, thereby obstructing and reducing so-called greenwashing.

While Art. 8 and 9 involve ‘ESG products’ that promote (Art. 8) environmental or social characteristics or have sustainable investments as their objective (Art. 9), Art. 6 products are often (incorrectly) considered to be funds with no relevance for sustainability-related issues. In fact, it should be pointed out that the aforementioned statutory regulatory framework has actually impacted every product, manager and management company. The common denominator here is the issue of transparency when handling sustainability risks (Art. 6). This minimum level of transparency has to be disclosed for each product.

And this has naturally gone further for ‘green’ products: here, the new regulatory requirements affect every stage of the fund lifecycle. This starts with acquiring new ESG data, followed by new ESG due diligence requirements for delegated managers and advisors, extensive disclosure obligations in pre-contractual fund documentation and on websites, compliance with new ESG investments restrictions and, ultimately, the periodic ESG reporting that is currently under way. Alongside regulatory mandatory disclosures, there is also the requirement driven by MiFID to provide a consolidated version of the information from the aforementioned documents in a machine-readable format: the European ESG Template (EET). And all this can only happen with the necessary resources, processes, ESG data and suitable technology to process this.

Here, VP Fund Solutions relies on one of the main ESG data providers - MSCI. MSCI currently offers more than 3,500 ESG data points per asset that we can acquire and process using new IT solutions. So – unlike some of our peers – we have been in a position to calculate the so-called ‘PAI data’ (Principal Adverse Impact indicators) for all liquid funds using an in-house solution since 1 January.

Nonetheless, ESG data – particularly the lack of ESG data in the illiquid asset sector – remains one of the main subjects under discussion in the market that is considered to have the greatest potential for further development in the years to come. 

Despite the highly complex regulation and ongoing lack of market standards, ESG funds are more popular than ever as is clearly shown by the ever-increasing number of ‘green’ funds. According to an analysis by PricewaterhouseCoopers in mid-2022, more than half of all assets in the UCITS sector were held in ESG funds in Europe's largest fund domicile, Luxembourg, and this trend is set to continue. At the same time, the market experienced a wave of ‘downgradings’ from Art. 9 to Art. 8 at the end of 2022, attributable to continuing high regulatory uncertainty in relation to sustainable investments, taxonomy and, above all, the lack of reliable data somewhat sparse data situation. Indeed, one thing is clear: anyone claiming to invest in implement sustainable investments also needs to be able to prove this with corresponding figures. And such proof can be hard to come by, particularly when it comes to alternative investments.

Most investment managers have recognised the complexity of the regulation, the risk of greenwashing and the need for a flawless ESG database and are treating the subject accordingly: recognising the potential, but not rushing rashly towards Art. 9.

At VP Fund Solutions, we have the same understanding of this complex issue – together with our clients – and have taken a cautious approach for the last two years. So far, we have classified almost 20% of the funds under our administration at our locations in Luxembourg and Liechtenstein as ESG funds and carried out the corresponding ESG publications and documentation. We are seeing a clear trend towards ESG funds in new onboardings – particularly for Art. 8 products.

The VP Fund Solutions team has invested a huge amount of time and resources over the last two years in developing the necessary processes, acquiring suitable data and enhancing employee knowledge. We look forward to continuing to support you in this exciting journey