The Disclosure Regulation is considered by many a strategic regulation with long lasting effects for the fund management industry. Since its introduction, a great deal of attention has been paid to the implications of ESG Disclosures on the operations of fund managers, including a recent lengthy debate on the lack of specific guidance in the implementation due to the delay of the second level regulation.
A change in perspective was triggered recently with the introduction by the ESAs of templates for ESG Disclosures as well as the related advice issued by the SMSG on these templates. In a nutshell, the SMSG purports that retail investors are at risk of information overload with the templates in the form proposed. This could in principle also frustrate the aim of mitigating so-called greenwashing practices at the core of the Disclosure Regulation. At the same time, the SMSG seems to advocate for a more retail friendly way to present the ESG Disclosure, proposing that one single document is used to present retail investors with all relevant information, both financial and non-financial in nature.
The questions asked by many is whether UCITS KIIDs, even though excluded by the definition of precontractual documentation under the Disclosure Regulation, will require the inclusion of some reference or ESG Disclosures altogether.
Some of the Takeaways from the SMSG Advice
In September 2020 the ESAs launched a survey to gather feedback on templates for the ESG Disclosures related to products under article 8 and 9 respectively of the Disclosure Regulation. The idea behind the introduction of the templates was to gather feedback and consensus about the most optimal way to present ESG related information in a standardized fashion. The SMSG decided to issue specific advice rather than simply responding to the survey. The SMSG advice is worthy of mention, given that it diverges significantly from some of the principles contained in the level one Disclosure Regulation.
As many of you know already, the main idea behind the Disclosure Regulation is that ESG disclosures should be integrated within specific existing pre-contractual documentation. If we look at UCITS products, for instance, ESG disclosures should be contained in the prospectus. However, as highlighted by the SMSG, UCITS prospectuses – or offering memoranda of an Alternative Investment Fund – are very different in format and do not lend themselves to easy comparability of products. And given that one of the aims of the Disclosure Regulation is to promote comparability, the SMSG purports that any such template for ESG disclosure should be presented as a separate annex to the existing pre-contractual documentation. Adopting this approach would ensure the desired degree of comparability and standardization of ESG Disclosures amongst different products.
At the same time, the SMSG highlights the issue of lengthiness of the templates for ESG Disclosure and the risk of information overload for retail investors. In the real world, the template for ESG Disclosure would represent an additional piece of documentation in addition to the existing marketing and pre-contractual documentation that an investor should take into account before proceeding with an investment. Too many pages of documentation to read according to the SMSG, with the risk that retail investors might neglect to consider ESG related or other features of the proposed investment.
The preference expressed by the SMSG would be that only one piece of precontractual documentation contained all the information required, both financial and non-financial in nature, at least for retail investors.
Changing the Rules about UCITS KIIDs?
From a regulatory standpoint, the SMSG suggests that a change in the UCITS directive could well accommodate non-financial information to be presented within UCITS KIIDs. The same result could be achieved by changing the first level regulation on PRIIPs as well as the Prospectus and PEPP regulation for other types of products. Interestingly enough, the UCITS directive will have to be amended in order to accommodate the integration of the sustainability risk by the end of 2020.
Whilst a similar proposal to amend the UCITS Directive could possibly require a prior consultation process, extending a potential timeline for implementation, we can see the rationale behind the provocative suggestion of the SMSG. On the one hand, as ESG related considerations will progressively become more important in the investment decision process of retail investors, it makes sense to consider and treat this type of information like any other type of financial information historically used to present an investment. On the other hand, the establishment of a market practice will also contribute to the streamlining of ESG Disclosures, which will be presented in a more succinct format.
UCITS KIIDs Annual Update and ESG Disclosures
Fund managers and promoters are required to update their UCITS KIIDs every year at least for what concerns the performance data. The timeline for the yearly UCITS KIIDs update is set for February 19th whilst the entry into application of some of the provisions of the Disclosure Regulation is set for March 10th 2021.
Many are still grappling with the question as to whether it makes sense to introduce any type of ESG reference in the UCITS KIIDs as part of the forthcoming annual update exercise, despite the fact that there is no specific requirement in the Disclosure Regulation. The question is appropriate in light of the timing of the UCITS KIIDs annual update. Having to introduce a change after the yearly update is completed may be a costly endeavor, especially for fund managers or promoters with a large production of UCITS KIIDs.
On this particular point the advice of the SMSG is along the lines of introducing a cross-referencing approach between the ESG Disclosure templates and other retail investor information on the other. The SMSG suggests the ESAs introduce a requirement that the ESG Disclosure templates include a link to other retail-specific precontractual documentation, the same as introduce guidelines to the extent that other precontractual documentation contain, as well a link to the ESG disclosure contained in the template.
For the lack of specific guidelines on the point and with no absolute certainty that these will either be issued or issued on time, the question about the UCITS KIIDs remains without a straightforward answer.
On the one hand, from a regulatory standpoint, the Disclosure Regulation does not impose any requirements on UCITS KIIDs. On the other, in addition to the advice of the SMSG, there might be commercial considerations – like establishing a product leadership in ESG – which makes the pendulum swing significantly towards the inclusion of some reference in the UCITS KIIDs.
For further information, please contact Attilio Veneziano, firstname.lastname@example.org
Press release distributed by PressHalo on behalf of Veneziano & Partners, on 22nd December, 2020.