One example is that you are based, or operate, or work with, or invest in, an EU based entity. You may want start asking yourself the following – basic – questions:
- Has your company adopted a written ESG/Sustainability investment policy/strategy? How you ensure effective engagement with investees so that you do not operate on exclusion but rather on engagement for sustainability based on concrete indicators and goals? Have you thought about the “implicit” strategy you may already have in place?
- Does your company consider sustainability/ESG as an integral part of your risk management? Are you ready to report meaningfully on Sustainable Finance Disclosure Requirements - including knowing when questions are truly non-applicable or ready to disclose when you are yet to obtain information?
- Do you have practical and pragmatical indicators on ESG/Sustainability which are linked to your strategy and which truly readies you for reporting on e.g. SFDR and other such regulation? Do your strategy and indicators allow you to capture small progress that your investees make on sustainability issues?
- Have you committed to a strategy addressing effects - positive and negative - on the societies of your investments? Do you have indicators based on international norms and SDGs which pragmatically aid you in your reporting and in making certain that you do no harm - or if you adhere to "implementing the SDGs" in your reporting you actual do so?
- Have you considered that by asking these questions of you Asset Manager (perhaps not on ALL AUMs in one go!) you can deduct an implicit sustainability policy/strategy which may already be rather well developed? And with confidence say "this does not apply to us" or "we are seeing this as an area to focus on" once questionnaires start arriving?
Why? Because very soon you will be asked to disclose on these issues. And it will be very good to know if not all, at least some of the answers – and also know why you do not HAVE some of the answers YET – as well as what questions simply do not apply to you.
Doing an initial screening of your asset managers portfolio, based on their policies and strategies but also looking into their investees actual ESG footprint, based on international standards which are at the basis of the SDGs and WILL BE the BASIS for ANY regulation coming from regional or national regulatory bodies, you can start to paint a picture of an implicit sustainability policy/strategy which may actually be much more elaborate than what is on paper, as well as discover the areas to work on. Importantly the knowledge this will give you, will allow you to say "this does not apply to me" once massive questionnaires start coming your way, as well as say with confidence where you are focusing on improving.
On 27th November 2019 EU Regulation No.2019/2088 on sustainability‐related disclosures in the financial services sector (SFDR) introduced a number of disclosure obligations for financial markets participants and financial advisers, most of which will become applicable on 10th March 2021. On 23rd April 2020, a public consultation on the content, methodologies and presentation of disclosures was launched by the European Supervisory Authorities (ESAs), and the Final Report on Draft Regulatory Technical Standards (RTS) was published on 2nd February 2021, leaving a very short time for implementation before the entry into force of the SFDR obligations (a general concern that was highlighted by the stakeholders who participated in the consultation, together with the need to ensure consistency with the Taxonomy Regulation and the Non-Financial Reporting Directive).
The SFDR aims at preventing greenwashing and ensuring data comparability through enhanced standardized transparency on sustainability within the financial markets. It provides proposals on sustainability disclosures in the field of principal adverse impact, pre-contractual product, website product, and product periodic disclosures. These obligations will impact not only EU entities, but also indirectly non-EU entities who provide services in the EU or use EU subsidiaries.
Besides requiring entities to understand the scope, severity, probability of occurrence and potentially irremediable character of the negative impact on the E that has been caused, compounded by or directly linked to its investment decisions and advice performed, the adverse sustainability impact set forth in the SFDR – mandatory for large entities and large holdings – requires considering the negative, material or likely to be material effects also on the S and the G, including requiring the publication of a statement on the entity’s website describing its due diligence policies in respect of these adverse impacts. The SFDR defines mandatory and voluntary adverse sustainability indicators and metrics in relation to social and employee matters, respect for human rights, anti-corruption and anti-bribery. The pre-defined sustainability factors provided in a template include 16 social mandatory indicators and 7 social voluntary indicators. This has resulted to be overall widely supported among stakeholders, although a big challenge that will likely be encountered in delivering these indicators will be the lack of data and the absence of a reliable source to calculate social and governance related indicators. Despite acknowledging these concerns in its final report, the ESAs have reiterated that “the inclusion of social indicators with this package of RTS is beneficial in terms of simplicity and predictability for financial market participants and for comparability purposes for investors”.
There is also a heightened awareness as to what ESG actually has to be understood as, when read in context - that when we speak about ESG it has to be understood in the sense of the SDGs: that is at 360 degrees – it is not enough to focus on the environment and think that an investment is sustainable “simply” - in quotation marks -because it is “Green” - one has to consider also the effects on the societal levels too. Investments on environmental projects in energy for instance , often do not report on the potential positive effects that they have the societal, but they do also not necessarily weigh in the potential negative effects. An example could be an investor or asset manager who is focusing on investing in solar panels but is not considering how do solar panels have been produced, whether or not labour conditions live up to international standards or whether the workforce is being exploited. Another thing could be focusing on clean water; in this case very often in reporting and decision making, the investor/asset manager would focus only on the SDG on water and not consider the positive “spill-over” effects such as: if you have clean water if you live in a rural area for instance the crops will be healthier and your livelihood will be positively impacted; if you have clean water you will have better health - and for children for instance if they have better health they attend school, and this in turn has long-term consequences on their ability to find jobs, to make informed choices and to participate in society.
All of these issues are a right in international law: the right to water within the right to a decent standard of living; the right to education; the right to an environment in which you are able to search for adequate employment; the right to participation; so these could be very positive spillover effect of an investment in clean water which today are rarely captured.
Measuring potential negative consequences could be if you are focusing on hydro energy and building a dam which will provide clean energy for let's say two million people in a certain area but you have to displace 350,000 from their homes and from the current livelihood. Does this mean that you are prevented from building the damn? No, not necessarily but there is a need to put certain measures in place: relocation plans which respect the rights and the interests of the people who will be relocated and prevent them from suffering displacement for instance.
Importantly the disclosure will not only be on financial products labelled “impact” or “sustainable” but mainstreamed. This is closely linked, but also distinct, from the upcoming Human Rights Due Diligence Requirements for companies operating in, or out of Europe. Investors will by now be required to be able not necessarily to answer all questions, but to be able to understand the effects on sustainability of the investments and at least ask the right questions of the investees – and the same goes for asset owners of their asset managers. One option could seem, for investors as asset managers, to pull out of any investment which may be complex, in a complex sector or in a complex geographical area. However, from both an investments perspective, as well as from a sustainability perspective that would be a mistake. It would narrow down investment portfolios to a range of products which would harm many asset managers, and it would have an adverse effect if we want to further sustainability – which at the end of the day is the goal of the EU Regulations. The first step in both being ready, and in taking steps to follow these regulations has to be transparency and engagement. But this requires real sustainability experience and sustainability professionals to assist in preparations, due diligence, reporting, and engagement with investees, communities and the EU institutions.
This is closely linked to the Human Rights Due Diligence requirements which are being drafted. On 29th April 2020 the European Commissioner for Justice announced that the EU Commission plans to submit a formal legislative proposal by 2021 (expected to come into force by early 2022) requiring businesses to carry out mandatory due diligence in relation to the potential human rights and environmental impacts of their own operations and value chains. On 26th October 2020, the EU Commission launched a public consultation on a possible initiative on sustainable corporate governance, after the European Parliament had proactively published its own draft text and recommendations for an EU Directive on corporate due diligence, which may indicate the position that it will adopt in response to the future proposal of the Commission.
In line with the EU Commissioner’s statement, the recommendations of the European Parliament and the ongoing consultations, it is likely that the UNGPs will be taken as guidance in the definition of the scope of the HRDD obligations. The mandatory due diligence duty, expected to be a legal standard of care, will therefore likely be enshrined in a cross-sectoral regulatory measure, applicable also to SMEs (although with ad hoc treatment), and requiring not only EU based companies, but all EU operating companies to identify, prevent, and mitigate adverse human rights and environmental impacts on their entire upstream and downstream value chain, even if such impacts do not take place within EU borders. It further seems likely that any future HRDD would apply to all human rights and cover all violations regardless of their severity – thereby avoiding legal uncertainties and the artificial separation of human rights – as well as provide for additional measures for vulnerable groups based on current human rights treaties and instruments such as CEDAW, CRC, CRPD and UNDRIP.
