Sustainable Finance In Luxembourg — What Managers Should Do Now

Regulation (EU) 2019/2088 of 27 November, 2019 on sustainability-related disclosures in the financial services sector, as amended by Regulation (EU) of 18 June, 2020 on the establishment of a framework to facilitate sustainable investment (the “SFDR”) will come into force on 10 March, 2021. Now is the time for AIFMs, UCITs managers, managers of EuVECA and EuSEF funds, MIFID investment advisers, investment firms providing portfolio management as well as any non-EU managers managing a Luxembourg fund or marketing funds in the EU under NPPRs to look into their compliance with the high level principles in the SFDR.

The draft regulatory technical standards relating to the SFDR (“RTS”) were due to be developed jointly by the EBA, EIOPA and ESMA by 30 December, 2020, but this ambitious deadline was extended on 30 October, 2020 given the COVID-19 pandemic. The Level 1 general principles of sustainability-related disclosures must be implemented by 10 March, 2021 and these include disclosures at the product (fund) level and disclosures at the entity (asset manager) level. This means that many assets managers have to make a significant effort now to think about their strategy on sustainable finance, and the CSSF issued a press release on 16 December, 2020 providing clarifications on the regulatory requirement applying to Luxembourg managers and as applicable, Luxembourg funds and implementing a fast track procedure to comply with such requirements.

What does it mean for asset managers’ existing practices?

An asset manager must make a business decision to either: (a) implement a due diligence policy with respect to the principal adverse impacts of its investment decisions on sustainability factors, at the level of the manager as an entity or (b) explain the reasons why it does not consider such adverse impacts. In turn, the same exercise will have to be done for each financial product that it makes available, with additional disclosures to be made for a financial product with a specific sustainability-focus. In addition, they have to assess and, as applicable, review their product strategy and classify their financial products according to three main categories (and adapt their offering documents and website accordingly). From an operational perspective, managers may have to update their internal processes to ensure that data takes into account the new transparency requirements (including ESG risks, investor preferences, categorization of the fund for distribution, reporting, etc.).

Transparency required on websites

The SFDR requires asset managers to disclose specific information on their website, in the pre-contractual information for a financial product, and (in some cases) in the periodic information provided to investors. This means that asset managers must first adopt a policy on the integration of sustainability risks in the manager’s investment decision-making process, noting that a sustainability risk under the SFDR is “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.”

Transparency must be included on managers’ websites with regard to policies on the integration of sustainability risks, the consideration of adverse sustainability impacts and the provision of sustainability-related information, and the website shall provide information including how ESG risks in all their investment decision/advice are considered and the negative impact, if any, that companies in portfolio have on environment or social matters.

What needs to be done with respect to the funds’ documents?

The SFDR applies to all financial products, and that includes funds. Article 6 of the SFDR requires that managers of UCITs or AIFs disclose how sustainability risks are integrated in their investment decisions as well as assess and disclose what could be the likely impact of such risks on the returns of a UCITS/AIF. As per the press release, the sustainability risk assessment approach and related disclosures feed into UCITS prospectus or as applicable, are made available to AIF investors in accordance with Article 6(3)(a) of the SFDR. Where the sustainability risk assessment by the managers of UCITs or AIFs leads to the conclusion that there are no sustainability risks deemed to be relevant for the fund it manages, the reasons should be explained in the UCITS prospectus or as applicable, be made available to AIF investors in accordance with Article 6(3)(a) of the SFDR. In addition, managers of UCITs or AIFs must provide adequate disclosures in UCITS prospectus or as applicable, inform AIF investors by 10 March, 2021 in relation to Article 7(2) SFDR when they do not consider adverse impacts of investment decisions on sustainability factors for the fund they manage.

Specific considerations must be given to funds that are financial products that (i) promote, among other characteristics, environmental or social characteristics, or a combination of those characteristics according to Article 8 SFDR or (b) do have sustainable investment as their objective according to Article 9 SFDR. In such case, the UCITS prospectus may also need to be modified or as applicable, the investors in the AIF must be informed in accordance with the provisions of SFDR.

Fast track procedure with the CSSF

The CSSF’s press release of 16 December, 2020 spells out the process to be followed by fund managers to comply with disclosure rules under the SFDR. This fast track procedure, for UCITS as well as Part II Undertakings for Collective Investment and Specialised Investment Funds, is implemented by the CSSF given that compliance with the SFDR is particularly challenging and must be implemented within a very short timeline (by 10 March, 2021). In order to benefit from the fast track procedure, managers of UCITs or AIFs must submit by 28 February, 2021 an updated version of offering documents to the CSSF (i.e., the prospectus for UCITS or the disclosures to investors referred to in Article 23 (1) of the AIFMD together with a self-certification letter) available on the CSSF website, here. Details of the fast track procedure can be found here.

For the avoidance of doubt, the fast track procedure for investment funds only applies for changes to the fund’s documents to comply with the SFDR, i.e., any material change that may apply, for instance to the investment policy and investment restrictions as defined in CSSF Circular 14/591, would not qualify for the fast track procedure and be subject to the standard procedure that applies to material changes to funds documents.