UK And EU Sustainable Finance Regulation: Taking Stock With Change On The Horizon – M&A/Private Equity

Current considerations

• Closed-ended funds: For closed-ended funds
  classified as Article 8 or 9 under SFDR, there remains an ongoing
  obligation to provide website and periodic reporting in compliance
  with the SFDR Regulatory Technical Standards (SFDR Level 2), with
  effect from 1 January 2023 (which we wrote about here). Where no SFDR Level 2 pre-contractual
  disclosure is in place, there can be additional challenges in
  meeting these disclosure requirements. SFDR Level 2 often drives
  practical actions, policies and procedures that are implemented in
  the investment lifecycle. With no SFDR Level 2 pre-contractual
  disclosure triggering certain SFDR Level 2 concepts and
  considerations, there can be gaps when it comes to making the SFDR
  Level 2 periodic reports in particular. We recommend that for any
  closed-ended funds in this situation, the SFDR Level 2 periodic
  reporting template is reviewed in good time ahead of
  publication.




• New strategies: Guidance from the European
  Commission, European Securities and Markets Authority (ESMA) and
  local regulators, has consistently moved the needle on key areas
  such as good governance and principal adverse impacts. As such,
  there may be additional considerations for new strategies to meet
  the current regulatory and market expectations, in comparison to
  previous strategies. We recommend care is taken in any reliance on
  disclosures and approaches from previous funds.

Future developments

• The European Supervisory Authorities (ESAs) have consulted on
  significant changes to SFDR, in particular on:




• • principal adverse impacts (PAIs) with new social PAI
    indicators, inclusion of value chain information and derivative
    calculations;

  
  

  • the do no significant harm (DNSH) test for sustainable
    investments and whether to maintain the status quo, require
    further, more specific disclosures, or add in a safe harbour for
    certain Taxonomy-aligned investments – meaning no further
    DNSH SFDR disclosures are required;

  
  

  • whether further additional disclosures should be included where
    a strategy commits to greenhouse gas (GHG) emissions targets;
    and

  
  

  • updates to the template disclosures with a new
    “dashboard” to highlight all the critical information
    required in one place.
    

The deadline for responses was 4 July 2023. There is no set
timeline committed to for this consultation, although the updated
rules are currently expected to be published in Q4 2023 / Q1
2024.

• A political decision has reportedly been reached to carry out a
  comprehensive review of SFDR. This includes consulting on the very
  nature of SFDR as a disclosure and transparency regime, rather than
  as a labelling regime (which it has de facto become). The
  consultation is also set to review SFDR’s interaction with
  other sustainable legislation and regulation. We are expecting the
  consultation to be launched in September 2023 and will provide an
  update once it is published.

Current considerations

The EU Taxonomy Regulation is complex, particularly with the
technical screening criteria that must be followed for any
Taxonomy-aligned investment. Many firms focused on SFDR Level 2
compliance for 1 January 2023, parking analysis of the EU Taxonomy
Regulation. Now could be the time to re-explore any appetite for
Taxonomy-alignment moving forward, particularly as it is expanding
to cover further sectors and activities as set out below.

Future developments

The EU Taxonomy Regulation is expanding to include technical
screening criteria for the remaining four environmental objectives
not yet covered:

1. sustainable use and protection of water and marine
   resources;




2. transition to a circular economy;




3. pollution prevention; and




4. control and protection and restoration of biodiversity and
   ecosystems.

There are also amended / new sectors and activities for the
existing “climate change mitigation” and “climate
change adaptation” objectives covering, for example, aviation,
construction and manufacturing.

The expansion, with effect from 1 January 2024, could present an
opportunity for some to explore Taxonomy-alignment for investments
based on these new activities and sectors.

UK ESG Sourcebook – Task
Force on Climate-Related Financial Disclosures (TCFD)
reporting

Current considerations

As discussed in our update here, certain UK authorised firms are required
to make TCFD reports at both entity and product level. To recap, as
well as covering asset managers more typically considered under
that term, such as AIFMs, the FCA’s ESG Sourcebook also
captures portfolio managers and firms which carry on private equity
or other private market activities. The latter consists of either
advising on investments on a recurring or ongoing basis, in
connection with an arrangement the predominant purpose of which is
investment in unlisted securities (this could include a UK
authorised firm that provides investment advice to a fund
manager).

We are significantly into the reporting period for the second
phase of in-scope firms with assets under management greater than
£5 billion, but less than £50 billion (such threshold
to be reviewed after three years of disclosures). The reports for
this calendar year of 2023 will need to be made by 30 June 2024. We
recommend any in-scope firms that have not recently reviewed their
obligations and progress towards being able to report, do so as a
priority.

There is also a mechanism where in-scope firms of the ESG
Sourcebook can make on-demand requests for data to support them
with making their TCFD disclosures, for example, where the in-scope
firm has delegated portfolio management to another UK regulated
firm. In this case it could be that the UK regulated firm that has
the demand placed on them is outside of the ESG Sourcebook
requirements directly, but is brought within its remit via the
demand, and they may not be prepared to comply with the request.
Whether intending to make an “on-demand request” or
potentially being the recipient of one, one avenue to achieve
certainty can be to contractually agree the data to be provided,
including any methodologies and timing.

In addition, an investor in an unauthorised AIF managed by a UK
AIFM may also make an on-demand request.

UK Sustainability Disclosure
Requirements/Green Taxonomy

Future developments

The UK’s Sustainability Disclosure Requirements (SDR)
covering labelling, disclosure and anti-greenwashing rules for UK
regulated entities and funds are delayed, with the UK Financial
Conduct Authority (FCA) stating that they intend to publish them in
Q4 2023.

The anti-greenwashing rule is expected to apply to all
FCA-regulated firms and apply from the date of the SDR Policy
Statement (with the disclosure and labelling rules expected to be
phased in over time). The new anti-greenwashing rule is to set out
that sustainability-related claims should be clear, fair and not
misleading and consistent with the sustainability profile of
products or services provided. UK regulated firms are recommended
to consider their marketing procedures and internal governance with
regards to sustainability claims to help minimise the risk of
greenwashing claims, particularly in the context of this new
regulatory rule.

We are expecting some significant changes to the SDR consulted
on in terms of disclosure requirements and labels but consider it
unlikely that overseas managers and funds will be brought into
scope initially. We also expect the requirements to remain lighter
where there are no retail investors. Nevertheless, where there is a
UK regulated entity or fund within a structure, SDR will need to be
carefully reviewed once published and we will publish an update at
the relevant time.

On 1 September 2023, the Green Technical Advisory Group (GTAG)
published its latest papers on the development of a UK Taxonomy.
GTAG is advising the UK government on options for the UK Taxonomy
and making recommendations for the shape it should take. Some of
the headlines from GTAG’s recent papers include:

1. a need to implement a UK Taxonomy of some form on
   “green” economic activities as soon as possible as the
   timetable is already significantly delayed – with the UK
   Taxonomy covering transition and harmful activities at a later
   stage;




2. setting out that the EU Taxonomy is generally a “good
   fit” for the UK and that there would be limited benefit from
   significant divergence which, if followed through, will support
   with its international interoperability;




3. a call for an expansion in the UK Taxonomy to cover more
   activities in wholesale and retail trade, manufacturing,
   agriculture and potentially financial and advisory services;
   and




4. that the UK Taxonomy reporting on turnover and CapEx should be
   mandatory but OpEx should be optional, in contrast to the EU
   Taxonomy which also makes this KPI mandatory. As with SDR, we will
   provide an update when there is further news on the UK
   Taxonomy.

EU AIFMD/EU
MiFID

Current consideration

Sustainability-related updates to EU AIFMD and EU MiFID (but not
UK AIFMD or UK MiFID) took effect from 1 August 2022 last year.
Where there is an EU AIFM or entity captured by EU MiFID in a
structure, there could be additional sustainability-related
considerations. For example, EU AIFMs are required under the
updated legislation to consider sustainability risks in the
selection and ongoing monitoring of investments, as well as in risk
management processes, and will need to document this. There may be
analysis needed within delegation models where some parties are,
and others are not, within scope of EU AIFMD or EU MiFID to ensure
all parties agree the expected approaches to sustainability factors
and/or risks.

Litigation and regulatory
enforcement risk

Current consideration

A common theme of most regulatory enforcement cases has been
that there is a disjunct between marketing materials and underlying
fund documentation, in terms of sustainability claims and
commitments. With the imminent introduction of the FCA’s
anti-greenwashing rule in the UK, that in its draft form is focused
on consistency in claims and the sustainability profile of
financial products, and ESMA having consulted on
sustainable/ESG-related fund names and requirements, a review of
marketing procedures to ensure alignment with fund documentation
and to help mitigate greenwashing enforcement is strongly
recommended.

The disclosures triggered by the myriad of EU and UK
regulations, which are continuously evolving, form a source of
material that can be used in litigation claims against asset
managers. In the UK this may include misrepresentation or
mis-selling claims, as examples. Firms should consider analysing
their risk of potential greenwashing-related claims and any
subsequent mitigating actions that can be taken. The majority of
the mitigating actions are rooted in the applicability and
implementation of the regulatory requirements in organisations and
at fund level.