UK: Sustainable Finance Report From The Luxembourg Regulator

The Commission de Surveillance du Secteur Financier ("CSSF") recently published its observations and recommendations on the implementation of sustainability-related provisions in the investment fund industry as part of its supervisory work in the area of sustainable finance.

The feedback takes into consideration (i) the Sustainable Finance Disclosure Regulation ("SFDR"), (ii) the SFDR Regulatory Technical Standards ("SFDR RTS"), (iii) the Taxonomy Regulation and (iv) the ESMA supervisory briefing on sustainability risks and disclosures in the area of investment management published in May 2022.

Following on from the ESMA supervisory briefing and the publication of the CSSF's own supervisory priorities in the area of sustainable finance in April 2023, the CSSF's report summarises its findings from its recent review of firms and sets out its recommendations for improvements.

1 Organisational arrangements of IFMs

Integration of sustainability risks

AIFMs and UCITS Mancos are collectively referred to as investment fund managers or "IFMs" in Luxembourg and we will use this term for the remainder of this briefing.

IFMs are required to integrate sustainability risks into their risk management policies. The CSSF observed that:

• sustainability risks may be relevant to all funds: that includes, but is not limited to, "those funds not disclosing under article 8/9 SFDR" – i.e. so-called Article 6 funds;
  
• an adequate sustainability risk management process should: (i) reflect any relevant sustainability risks, (ii) have corresponding sustainability risk indicators, (iii) have a risk limitation system and (iv) corresponding reporting to the senior management and board of directors. Where relevant the framework may need to include stress testing and scenario analysis;
  
• in its view the integration of sustainability risks in risk management processes is not simply limited to verifying the compliance of funds with ESG-related investment restrictions set out in precontractual disclosures: IFMs should adopt a holistic view.
  

Delegation to third parties

In the context of delegation to third parties (for example, where a Lux AIFM delegates portfolio management to a UK firm):

• IFMs remain responsible for the SFDR disclosure requirements applicable to their funds despite such delegation;
  
• IFMs' due diligence on delegated portfolio managers should take due account of how those managers embed sustainability-related provisions in their investment decisions.
  

Portfolio management and investment advice

Those IFMs performing discretionary mandates under a "MiFID top-up" are reminded that they must comply with the SFDR disclosure framework at all times.

Consideration of principal adverse impacts ("PAIs")

Under the SFDR RTS, where IFMs consider the PAIs of investment decisions on sustainability factors, they are required to publish a statement in a dedicated section of their website. The first statement was due on 30 June 2023.

2 Disclosures

As an overriding principle, the pre-contractual and website disclosures should be drafted in a manner that is easily accessible, non-discriminatory, prominent, simple, concise, comprehensive, fair, clear and not misleading to investors.

For article 8 and 9 SFDR funds, the CSSF notes that IFMs must ensure that all information is available on their website or though links to the relevant website disclosures of the fund.

Precontractual disclosures

The following items were emphasised by the CSSF:

• Disclosure of the environmental/social characteristics: the objectives/promoted characteristics shall be clearly identified and general descriptions should be avoided.
  
• Fund names: as set out in the CSSF's FAQs on SFDR, the name of a fund must not be misleading and should be appropriate to the E/S characteristics / sustainable objectives promoted by such fund. The CSSF points to ESMA's supervisory briefing on sustainability risks and disclosures in the areas of investment management (May 2022) and expects IFMs to keep abreast of European developments in this area.
  
• Definition of sustainable investment: the CSSF has echoed the European Commission's latest guidance on SFDR (as set out in its FAQs, which were updated in April 2023, and incorporated into the consolidated set of FAQs published by the ESAs in May 2023) and expects IFMs to carry out their own assessment of sustainable investments and to disclose the underlying assumptions used. The CSSF expects that this information should be provided as part of (i) the precontractual disclosures and/or (ii) the product level website disclosures.
  
• Fund asset allocation: the asset allocation information should be disclosed in way which is coherent (i.e. aligned and comprehensive) with regard to the environmental/social characteristics promoted by the fund or the sustainable investment objective pursued by the fund. This must be consistent with the fund's investment policy and also be aligned with the overall minimum proportion of sustainable investments that is contemplated.
  
• Consideration of PAIs at product level: the CSSF has noticed that precontractual disclosure of PAIs on sustainability factors has mostly been at entity level, rather than product level and reminds IFMs to ensure compliance with such obligation in respect of individual funds.
  

Product website disclosures

The CSSF has clarified the following:

• "Summary" section: IFMs shall comply with the SFDR RTS' formatting requirements - i.e. a maximum length of two-sides of A4-sized paper when printed.
  
• "Data sources and processing" section: the CSSF suggested that good practice would be to present this section in tabular form to provide clear and comprehensive description to investors (e.g. ESG metrics, data sources, definitions). Among other things, IFMs are required to describe measures taken to ensure data quality, processing of data and the proportion of data that is estimated.
  
• "Limitations to methodologies and data" section: the CSSF expects IFMs to provide a relevant and sufficiently detailed description while at the same time avoiding the use of technical jargon. It is good practice to provide illustrative or concrete examples of data limitations and an explanation as to why these limitations do not affect how the promoted environmental/social characteristics are met and/or do not impact upon the sustainable investment objective.
  
• "Engagement policies" section: the CSSF expects IFMs to provide relevant and sufficiently detailed information on their engagement policies.

3 Compliance of periodic disclosure information

The CSSF has clarified how IFMs should answer the following questions in their annual reports (in accordance with the SFDR RTS templates):

• To what extent were the environmental and/or social characteristics promoted by (or sustainable investment objective) this financial product met? The CSSF expects IFMs to (i) present the performance of the fund's sustainability indicators used to measure the fund's performance and (ii) provide contextual information on the sustainability indicators used, including information on any relevant underlying methodology or details on any quantitative assessment of a fund's performance against its promoted characteristics/ sustainable investment objective.
  
• Consideration of PAIs: where a fund considers PAIs, IFMs should provide sufficiently detailed product-level information. Therefore, the reference in the periodic disclosures to a global policy adopted by the IFM and applicable to all the funds it manages, without any disclosure on individual funds, is not sufficient.
  
• What actions have been taken to meet the environmental/social characteristics (or sustainable investment objective) during the reference period? Concrete examples of relevant actions/engagements by the IFM shall be made in respect of each fund. Again, references to global initiatives applicable to all funds managed are not sufficient in this regard.

4 Fund documentation and marketing communications

The CSSF clarified the importance of the following with regard to the marketing communications:

• consistency with the terms of the legal and regulatory fund documents (including SFDR precontractual disclosures);
  
• reference to credentials (i.e. the product-level sustainability credentials such as ESG labels, ESG ratings or ESG certifications) should include clear references to the entity which issued such credentials, the entity that has been granted such credentials and the date on which such credentials were granted. Good practice includes the addition of clear and visible references in fund marketing communications which includes a hyperlink to the website where further information on the relevant credentials may be found.

5 Portfolio analysis

The CSSF reminds IFMs that they should take the European Commission's answers on the interpretation of SFDR into account when monitoring the ongoing compliance of the investment portfolios of Article 8/9 funds

For example, where exclusion policies are set out in the precontractual disclosures, the CSSF expects that all portfolio holdings comply with those exclusion policies at all times and that their design is consistent with the sustainable objective (Article 9 fund) or the promoted environmental/social characteristics (Article 8 fund).

The CSSF expects that its observations summarised above will be considered by the IFMs and if necessary, corrective measures will be taken.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.