In our previous Sidley Update on the EU Sustainable Finance Disclosure Regulation (SFDR), we set out the content of the disclosure obligations that are expected to apply to non-EU alternative investment fund managers (AIFMs) that market alternative investment funds (AIFs) via the national private placement regimes under Article 42 of the Alternative Investment Fund Managers Directive (AIFMD).
The disclosure obligations under the SFDR begin March 10, 2021. A summary table of the relevant obligations is set out in the Annex here . In this Sidley Update, we outline key action items for in-scope AIFMs to consider ahead of the March 10 start date.
Does the SFDR apply to non-EU AIFMs?
As noted in our previous Sidley Update, based on previous guidance from the European Commission, the investment funds industry has been proceeding on the basis that the SFDR disclosure obligations apply to non-EU AIFMs that market their AIFs into the European Union.
However, on January 7, 2021, the European Supervisory Authorities (ESAs) wrote a letter to the European Commission (the ESA Letter) with a number of fundamental threshold questions relating to the application of the SFDR, including the following:
“Does SFDR apply to non-EU AIFMs, for example when they market a sustainable EU Alternative Investment Fund under a National Private Placement Regime?”
It would appear that the European Commission could respond to the above question in one of three ways:
- the SFDR does not apply;
- the SFDR applies in part; e.g., a non-EU AIFM must comply with the product-level disclosures but not the entity level (website) disclosures; or
- the SFDR applies in full.
Given the looming March 10, 2021 start date for the SFDR, it may be prudent for non-EU AIFMs to work on the current industry assumption that the SFDR disclosure obligations will apply.
Key action items for non-EU AIFMs marketing AIFs into the EU
1. Consider sustainability risks in relation to the firm’s investment strategies
The SFDR defines “sustainability risk” as:
an environmental, social or governance event or condition that, if it occurs, could cause an actual or a potential material negative impact on the value of the investment.
The focus, therefore, is on ESG events or conditions that could have a negative impact on the fund’s financial performance, rather than on the potential for the fund to have a negative impact on ESG factors.
If sustainability risks are relevant to the firm’s investment strategies:
- Consider the manner in which sustainability risks are integrated into the firm’s investment decisions.
- Assess the likely impacts of sustainability risks on the returns of the fund.
- Consider whether and how the firm’s remuneration policies are consistent with the integration of sustainability risks.
- Draft disclosures on sustainability risks for inclusion in investor-facing documents and, if applicable, public-facing disclosures on the firm’s website.
If sustainability risks are not relevant to the firm’s investment strategies (this might be the case, e.g., for a relative value product):
- Draft disclosures setting out a reasoned explanation as to why sustainability risks are not relevant, for inclusion in investor-facing documents and, if applicable, public-facing disclosures on the firm’s website.
2. Determine whether the firm has any “ESG products”
Firms should determine whether any of their funds that are marketed into the EU promote environmental or social characteristics (under Article 8 of the SFDR) or have sustainable investment or a reduction in carbon emissions as their objective (under Article 9 of the SFDR).
Firms whose funds fall within either Article 8 or Article 9 will be subject to additional, more detailed sustainability disclosures under the SFDR and will be required to disclose information in accordance with the EU Taxonomy Regulation, which complements the SFDR.
It should also be noted that the ESA Letter referred to above also features a question on the scope of Articles 8 and 9 of the SFDR, so specific guidance on this point from the European Commission may be forthcoming.
3. Determine whether the firm will consider the principal adverse impacts (PAIs) of its investment decisions on sustainability factors
Firms are required to consider PAIs only where the firm and its subsidiaries have more than 500 employees. Firms with fewer than 500 employees may decide to consider PAIs but are not required to do so.
If the firm is required to or otherwise decides to consider PAIs:
- Draft disclosures describing the firm’s due diligence policies with respect to PAIs, for inclusion in investor-facing documents and, if applicable, public-facing disclosures on the firm’s website.
If the firm is not required to and decides not to consider PAIs:
- Draft disclosures containing clear reasons why the firm does not do so, including, where relevant, information as to whether and when they intend to consider such adverse impacts, for inclusion in investor-facing documents and, if applicable, public-facing disclosures on the firm’s website.
Note that the start date for the PAI disclosures differs depending on the approach the firm takes with respect with PAIs.
4. Review existing ESG-related documentation to ensure consistency
Firms that already have public or investor-facing sustainability-related disclosures that have been made independently of the SFDR requirements should check that those existing disclosures are consistent with the content of the firm’s SFDR disclosures. Each firm should also take care to ensure that its marketing materials do not cause it inadvertently to fall within the scope of Article 8 or Article 9 of the SFDR (if that is not the firm’s intention).
Conclusion and how Sidley can help
The above steps – which are merely a summary – are likely to require the involvement of firms’ investment professionals as well as legal and compliance staff. The preparation of disclosures may necessitate internal agreement and may require the creation of new policies regarding the firm’s approach to sustainability risks.
Sidley has developed a template of disclosures for the purposes of AIFMs’ SFDR obligations. We would be happy to guide clients through how such disclosures could be adapted for the relevant firms and their products.
Sidley Austin LLP provides this information as a service to clients and other friends for educational purposes only. It should not be construed or relied on as legal advice or to create a lawyer-client relationship. Readers should not act upon this information without seeking advice from professional advisers.
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