ESG: What are the global issues for cross-border managers of real estate funds?

In the European Union, the Sustainable Finance Disclosure Regulation (SFDR) and Taxonomy Regulation impose very prescriptive requirements on financial disclosure.  The investment community continues to ready themselves for the SFDR product-level or “level 2” disclosure requirements which will take effect on 1 January 2023. The risk for EU and UK managers with cross-border business is that compliance with the SFDR may not be sufficient or guarantee compliance with the UK’s sustainability disclosure requirements (SDR) or the US’s ESG-related proposals from the Securities and Exchange Commission (SEC) for financial services firms and large companies, when introduced. Other regional differences are evidenced globally, for example, in Asia, the Association of Southeast Asian Nations (ASEAN) is developing its own ASEAN Taxonomy and to complicate matters further, the Jersey regulator has introduced ESG disclosure rules which apply solely to Jersey funds. In most cases, the regulators state that they have tried to align sustainability-related disclosures with international standards and industry feedback but in reality there are clear differences in approach, particularly around the labelling of products.

The EU's Taxonomy Regulation provides a classification system for what conditions have to be met for an economic activity to be classed as environmentally sustainable. The UK has signalled that it will introduce a version that is appropriate for the UK market in due course. 

US approach

The SEC has launched proposals for companies to make climate-related disclosures. In addition, in May 2022, the SEC published proposed rules to change the “Names Rule” which requires registered investment advisers, registered investment companies and business development companies (together “funds”) to disclose additional information about their ESG investment practices.

A concern for the asset management industry is how these individual regimes will evolve and the impact that will have on ESG compliance programs and disclosure requirements. Fund managers marketing into various jurisdictions may need to produce separate disclosure documents to comply with different jurisdictional requirements and this would significantly increase the compliance burden.

What is the position on regulation in the UK?

 In its discussion paper “Sustainability Disclosure Requirements (SDR) and investment labels” (DP21/14), published in November 2021, the UK’s Financial Conduct Authority (FCA) acknowledged that many UK firms and their products are subject to the SFDR when carrying out cross-border EU business.  The FCA sought views on the extent to which the UK sustainability disclosure requirements could remain as consistent as possible with the SFDR while reflecting the needs of the UK market. The hope was that the UK regime would remain broadly equivalent to that of the EU, however,the proposed SDR rules (CP22/20) published by the FCA on 25 October 2022 seem to depart in some areas from the approach taken in the SFDR. This is particularly relevant to the way in which the FCA approaches product classification and labelling when compared to the SFDR (which incidentally, the European Commission has confirmed is not and is not intended to be a labelling regime). The FCA has also stressed that the UK’s regime needs to be appropriate for the UK market.

Overseas funds and products are not currently within the scope of the UK SDR which focuses on asset managers and their UK-based fund products and portfolio management services. This means that for now, global managers who market their funds on a cross-border basis into the UK can continue business as usual. However, they will need to keep a watching brief on future developments from the FCA given the FCA’s indications that it intends to expand the SDR to overseas funds and products in a future consultation that will be published “in due course”.  It may also be relevant to consider the market expectations of investors who may expect increased disclosure whether it is a regulatory requirement or not.

A further point to bear in mind is that the FCA requires mandatory Task Force on Climate-related Financial Disclosure. These rules, published in January 2022, are currently in force for asset managers that have £50bn or more of Assets Under Management.  Where that is the case asset managers will need to make climate-related disclosures throughout the course of 2023 covering 2022. Managers with less than £50bn of Assets Under Management but more than £5bn will need to start reporting from 2024 for 2023.

On 12 May 2022, the UK government published a call for evidence on updating its 2019 Green Finance Strategy.  Some of the questions asked include how the UK can become the world's first net-zero-aligned financial centre and integrate environmental factors into financial decision-making and the role of government and regulators. It is also expected to provide more clarity on green finance opportunities for the UK .The call for evidence closed on 22 June 2022, and is still being considered by the government.    

Next Steps

The regulatory framework surrounding ESG requirements across different jurisdictions is similar but not consistent and managers of funds in multiple jurisdictions need to be increasingly alert to the current and any future differences in reporting. 

Authored by Rita Hunter and Melanie Johnson.