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It’s Not That Easy Being Green

James Tinworth, Partner, Fieldfisher, considers the challenges for alternative investment fund managers (AIFMs) wishing to offer light and dark green funds under Europe’s Sustainable Finance Disclosure Regulation (SFDR).

In this note, we will consider SFDR’s enhanced set of requirements that apply to both alternative investment funds (AIFs) that promote environmental or social characteristics (‘Article 8 Funds/Light Green Funds’) and AIFs that have “sustainable investment” as their objective (‘Article 9 Funds/Dark Green Funds’). We will refer to both sets of funds as ‘ESG Funds’.

Being a Light Green or a Dark Green Fund will result in (i) increased disclosure in the AIF’s offering documents or the AIFMD wrapper to the AIF’s offering documents; (ii) increased disclosure on the manager’s website; and (iii) increased disclosure in the AIF’s AIFMD-compliant annual report. Crucially, however, being a Light Green or a Dark Green Fund will give an EU-endorsed badge that will set the fund apart from potentially greenwashed funds and should make the fund more attractive to investors, in the EU and elsewhere.

This article is based on the draft Regulatory Technical Standards that were included in the Final Report of 2 February 2021 (the ‘Draft RTS’). The Draft RTS are expected to be endorsed within three months of their publication.

The EU supervisory authorities have recommended that the Draft RTS “can be used as a reference for the purposes of applying the provisions of Articles 2a, 4, 8, 9, and 10 of the SFDR” until the final RTS come into effect (expected to be on 1 January 2022).

It is a great shame that the EU chose to introduce the SFDR with this odd timing. Currently, nobody seems to be putting forward any ESG funds under the SFDR – even those funds that are likely to be able to meet the requirements of a Light Green or a Dark Green Fund – because of the lack of certainty surrounding the details of the compliance requirements.

In any event, SFDR is very much a stride in the right direction and the Light Green/Dark Green Fund model under the SFDR could prove to become a global brand like the UCITS fund or even the template that other markets follow. It would have been nice from day one, however, to have had clarity and certainty on compliance for financial market participants, including those in the UK and the US that market funds to European investors.

50 shades of grey; four shades of green?

Article 8 Funds are referred to as ‘Light Green Funds’; Article 9 Funds are referred to as ‘Dark Green Funds’.  I am no fan of these terms and note that the template disclosures in the Annexes to the Draft RTSs could be used to introduce the alternative terms of ‘Single Green’ and ‘Double Green’ (the Article 8 disclosures are indicated by a single green dot next to a white dot and the Article 9 disclosures are indicated by a two adjacent green dots). Until this catches on (!), we will continue refer to Light Green and Dark Green Funds.

In order to be an Article 8/Light Green Fund, the Fund must satisfy two requirements:

(1) The AIF must promote, among other characteristics, environmental or social characteristics, or a combination of those characteristics.

“Sustainability indicators” will need to be used to measure the attainment of each of the environmental or social characteristics promoted by the AIF and these indicators will need to be disclosed.

There may be some scope for defining one’s own “environmental or social characteristics” and/or setting one’s own “sustainability indicators”. The latter term is not defined, although the Tables in Annex I of the Draft RTS contains a list of “adverse sustainability indicators” and these can serve as a sensible starting point.

(2) The companies in which the investments are made should follow good governance practices, including with respect to sound management structures, employee relations, remuneration of staff and tax compliance.

The manager will need to have a policy to assess good governance practices of investee companies and will need to disclose this policy.

There are technically three types of Article 9/Dark Green Fund:

1. The AIF has “sustainable investment” as its objective and an index has been designated as a reference benchmark. (Article 9(1))

2. The AIF has “sustainable investment” as its objective and no index has been designated as a reference benchmark.  (Article 9(2))

3. The AIF has a reduction in carbon emissions as its objective. (Article 9(3)).

“Sustainable investment” is defined in the SFDR as:

(i) an investment in an economic activity that contributes to an environmental objective (as measured, for example, by key resource efficiency indicators on the use of energy, renewable energy, raw materials, water and land, on the production of waste, and greenhouse gas emissions, or on its impact on biodiversity and the circular economy); or

(ii) an investment in an economic activity that contributes to a social objective (in particular an investment that contributes to tackling inequality or that fosters social cohesion, social integration and labour relations, or an investment in human capital or economically or socially disadvantaged communities), provided that:

(a) such investments “do not significantly harm” any of those objectives; and

(b) the investee companies follow good governance practices, in particular with respect to sound management structures, employee relations, remuneration of staff and tax compliance.

Like Light Green Funds, the manager will need to have a policy to assess good governance practices of investee companies and will need to disclose this policy.

The principle of “do no significant harm” is closely linked to the SFDR disclosures relating to adverse impacts required under Article 4 of the SFDR. The Draft RTS provide that disclosure should “contain an explanation of how the investments of the [fund] do not significantly harm any of the sustainable investment objectives, including an explanation of:

(a) how the indicators for adverse impacts in Table 1 of Annex I and any relevant indicators in Tables 2 and 3 of Annex I, are taken into account; and

(b) whether the sustainable investment is aligned with the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights, including the principles and rights set out in the eight fundamental conventions identified in the Declaration of the International Labour Organisation on Fundamental Principles and Rights at Work and the International Bill of Human Rights.”

When managers are considering whether their funds can be Light Green or Dark Green, they will need to consider the underlying obligations and the disclosure that will be required. If a manager cannot satisfy these obligations or provide adequate disclosure then they will need to consider carefully whether they can defend a claim to be a managing a Light Green or Dark Green Fund.

Disclosure requirements in detail

Being a Light Green or a Dark Green Fund will result in (i) increased disclosure in the AIF’s offering documents or the AIFMD wrapper to the AIF’s offering documents; (ii) increased disclosure on the manager’s website; and (iii) increased disclosure in the AIF’s AIFMD-compliant annual report. We have set out summary tables of these three sets of requirements below.

1. Increased disclosure in the AIF’s offering documents or the AIFMD wrapper to the AIF’s offering documents:

Article 8/Light Green FundsArticle 9/Dark Green Funds
Articles 13-19 of the Draft RTSArticles 20-27 of the Draft RTS
Additional annex (template in Annex II of the Draft RTS) required with the following sections:Additional annex (template in Annex III of the Draft RTS) required with the following sections:
What environmental and/or social characteristics are promoted by this [fund]?
+ a list of the sustainability indicators used to measure the attainment of each of the environmental or social characteristics promoted by the fund
What is the sustainable investment objective of this [fund]?
+ a list of the sustainability indicators used to measure the attainment of the sustainable investment objective
What investment strategy does this [fund] follow?
+ a short description of the policy to assess good governance practices of the investee
companies
What investment strategy does this [fund] follow?
+ a short description of the policy to assess good governance practices of the investee
companies
What is the asset allocation planned for this [fund]?What is the asset allocation planned for this [fund]?
+ a description of how sustainable investments contribute to a sustainable investment objective and not significantly harm any sustainable investment objective (including the disclosure referred to above in "Article 9 ("Dark Green") Funds"
Does this [fund] take into account principal adverse impacts on sustainability factors?Does this [fund] take into account principal adverse impacts on sustainability factors?
Can I find more product specific information online?Can I find more product specific information online?
(where an index is designated as a reference benchmark for the purpose of attaining the environmental or social characteristics promoted by the [fund]) Is a specific index designated as a reference benchmark to determine whether this [fund] is aligned with the environmental and/or social characteristics that it promotes?(for a [fund] referred to in Article 9(1) of the SFDR)) Is a specific index designated as a reference benchmark to meet the sustainable investment objective?

(for a [fund] referred to in Article 9(3) of the SFDR) Does the [fund] have the objective of a reduction in carbon emissions?

2. Increased disclosure on the manager’s website:

The manager will need to publish the relevant information on their websites in a separate section titled, “Sustainability-related disclosures”.

Article 8/Light Green FundsArticle 9/Dark Green Funds
Articles 32-44 of the Draft RTSArticles 45-57 of the Draft RTS
Summary
- a summary of the information set out in this table of a maximum length of two sides of A4-sized paper when printed
+ there is a chance that this summary may need to be provided in one of the official languages of the relevant member state(s).
Summary
- a summary of the information set out in this table of a maximum length of two sides of A4-sized paper when printed
+ there is a chance that this summary may need to be provided in one of the official languages of the relevant member state(s).
Light Green Fund statement: “This financial product promotes environmental or social characteristics, but does not have as its objective a sustainable investment.”No significant harm to the sustainable investment objective
- similar disclosure referred to above in "Article 9 ("Dark Green") Funds"
Environmental or social characteristics of the [fund]Sustainable investment objective of the [fund]
Investment strategy
+ a description of the policy to assess good governance practices of the investee companies
Investment strategy
+ a description of the policy to assess good governance practices of the investee companies
Proportion of investments
- like "What is the asset allocation planned for this [fund]?" (see above)
Proportion of investments
- like "What is the asset allocation planned for this [fund]?" (see above)
Monitoring of environmental or social characteristics
- a description of how the environmental or social characteristics and the sustainability indicators are monitored throughout the lifecycle of the fund and the related internal or external control mechanisms.
Monitoring of environmental or social characteristics
- a description of how the sustainable investment objective and the sustainability indicators are monitored throughout the lifecycle of the fund and the related internal or external control mechanisms

Methodologies
- a description of the methodologies to measure the attainment of the social or environmental characteristics promoted by the fund using the sustainability indicators
Methodologies
- a description of the methodologies to measure the attainment of the sustainable investment objective using the sustainability
indicators
Data sources and processingData sources and processing
Limitations to methodologies and dataLimitations to methodologies and data
Due diligenceDue diligence
Engagement policiesEngagement policies
(where an index is designated as a reference benchmark for the purpose of attaining the environmental or social characteristics promoted by the [fund]) Designated reference benchmarkAttainment of the sustainable investment objective
- disclosures about the reference benchmark (for Article (1) and Article 9(3) ESG Funds)

3. Increased disclosure in the AIF’s AIFMD-compliant annual report (for periodic reports issued from 1 January 2022):

Article 8/Light Green FundsArticle 9/Dark Green Funds
Articles 58-63 of the Draft RTSArticles 64-70 of the Draft RTS
Additional annex (template in Annex IV of the Draft RTS) required with the following sections:Additional annex (template in Annex V of the Draft RTS) required with the following sections:
To what extent were the environmental and/or social characteristics promoted by this [fund] met?To what extent was the sustainable investment objective of this [fund] met?
What were the top investments of this [fund]?
- a list of the 15 investments constituting the greatest proportion of investments of the fund during the reference period, including the sector and countries of those investments.
Where the number of investments constituting 50 percent of the investments of the fund during the reference period is less than 15, a list of those investments, in descending order of size, including the sector and location of those investments
What were the top investments of this [fund]?
- a list of the 15 investments constituting the greatest proportion of investments of the fund during the reference period, including the sector and countries of those investments.
Where the number of investments constituting 50 percent of the investments of the fund during the reference period is less than 15, a list of those investments, in descending order of size, including the sector and location of those investments
What was the proportion of sustainability-related investments?What was the proportion of sustainability-related investments?
- like "What is the asset allocation planned for this [fund]?" (see above)
What actions have been taken to meet the environmental and/or social characteristics during the reference period?
- the actions taken within the reference period to attain the environmental or social characteristics promoted by the financial
product, including shareholder engagement as defined in Article 3g of Directive 2007/36/EC (The Shareholder Rights Directive)
and any other engagement relating to the environmental or social characteristics promoted by the fund.
What actions were taken to attain the sustainable investment objective during the reference period?
- the actions taken within the reference period to attain the sustainable investment objective of the fund, including shareholder engagement as defined in Article 3g of Directive 2007/36/EC (The Shareholder Rights Directive) and any other engagement relating to the sustainable investment objective.
(for a [fund] that designated an index as a reference benchmark to attain the environmental or social characteristics promoted by the [fund]) How did this [fund] perform compared to the designated reference benchmark?(for a [fund] referred to in Article 9(1) of Regulation (EU) 2019/2088) How did this [fund] perform compared to the reference sustainable benchmark?

(for a [fund] referred to in Article 9(3) of the SFDR) How was the objective of a reduction in carbon emissions aligned with the Paris Agreement?

This article was originally published here on www.fieldfisher.com

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