Getting Ready for EU SFDR: Impact of Sustainable Finance Disclosure Regulation

Key Takeaways

• • Michelle Auger: SFDR is a legislation from the European Union (EU), which reflects the political drive to connect finance with sustainability. The regulation’s primary purpose is for greater transparency and disclosure about what firms are doing and greater disclosure about how sustainability-oriented their projects are. We are taking a thoughtful and strategic approach to implementation. In phase one, we are going to market with a smaller number of high conviction sustainability focus funds, and these are going to be Article 8 and Article 9 funds.
  • David Zahn: Clients will see more focus on how we can make our funds more advanced in sustainability, and SFDR helps us fit into a framework. We have been running our European fixed income product range in a sustainable way in general already and have already integrated ESG fully into our products. I think it will be beneficial overall for people to understand exactly what we are doing. It will be spelled out verbatim in the prospectuses.
  • David Sheasby: What SFDR brings to the market is really about transparency and authenticity. I think it will effectively shine a light on what asset managers are doing—in our case what we largely are already doing. SFDR is not about a change in what we do, but formalising it, thinking about language that needs to go into the prospectuses, and how its articulated consistently.
  • Guy Janssens: SFDR is very important for us. We made a decision at a company-level a couple of years ago that we were going to be 100% sustainable; 100% of activity in funds and ETFs should become Article 8 and 9 in a couple of years, and we are in a phase of transition. We’re glad that this is coming, and we’re looking forward to the efforts of other asset managers.

Berengere Blaszczyk: What is the sustainable finance disclosure regulation (SFDR)? Ms. Auger, let’s start with you.

Michelle Auger: SFDR is legislation from the European Union (EU) which reflects the political drive to connect finance with sustainability. The regulation’s primary purpose is for greater transparency and disclosure about what firms are doing and greater disclosure about how sustainability-oriented their projects are. In some ways, you might say this regulation is about the EU going to war on the practice of “greenwashing.” At Franklin Templeton, we welcome the EU Sustainable Finance Disclosure Regulation (SFDR), which is an important step in driving forward transparency and authenticity in how investors approach ESG and sustainability.

This regulation is very much principles-based rather than prescriptive. Therefore, we have taken a thoughtful and strategic approach overall.

This is just a beginning. There is further reporting, more disclosures that the industry will need to fulfill because there is secondary legislation known as the regulatory technical standard that has further instructions. We, along with the rest of the industry, will seek to align with these instructions, which I foresee keeping us busy for quite a while.

Berengere Blaszczyk: And how has Franklin Templeton prepared for this?

Michelle Auger: As I mentioned, we agreed to take a more thoughtful and strategic approach. So, in phase one of our implementation of the SFDR, we are going to market with a smaller number of high- conviction sustainability focus funds, and these are going to be Article 8 and Article 9 funds. And in terms of what this means for clients, our legal and marketing teams have done a great job. They have been working tirelessly these past few months to prepare these pre-contractual documents and associated marketing materials. Prospectuses have been filed and website disclosures are ready. The marketing materials have been reviewed and are consistent with the new disclosure requirements.

Berengere Blaszczyk: Mr. Janssens, can you tell us a bit more about how you have adapted to SFDR at BNP?

Guy Janssens: For us, SFDR is very important. We made a decision at a company-level a couple of years ago that we were going to be 100% sustainable. We have a goal that 100% of activity in funds and exchange-traded funds (ETFs) should become Article 8 and 9 in a couple of years, and we are in a phase of transition. It means that all our products have to integrate the exclusions policies, environmental, social and governance (ESG) integration, and engagement, which is very important. And of course, the disclosure. For the Belgian labels, there’s a lot of disclosure on an asset management company. We go a little further in Europe also in disclosure on the product level, so, we’re glad that there is European framework because we are working within BNP Group, which is a European bank. It will improve the liquidity and the offering of the products that we can choose in Belgium. So, we’re glad that this is coming, and we’re looking forward to the efforts that will be coming also from Franklin Templeton and also from other asset managers to give more disclosure and develop products regarding Article 8 and Article 9.

Berengere Blaszczyk: Mr. Zahn, how is SFDR impacting your life as a European fixed income portfolio manager?

David Zahn: Implementation of this particular EU regulation was a natural progression for our European product range, because we have been running our European fixed income product range in a sustainable way in general for a while. In this respect, we were delighted that some of our funds were awarded labels such as Febelfin that validate and recognise our ESG process. So, from that perspective, we’ve already integrated ESG fully into our products. We’ve already put in many of the exclusions and have done so for several years. So, we’re formalising this into our prospectuses—we had some but not all of it. It’s more about formalising it so that everyone understands what we are doing. However, I don’t see this as an end goal that we want to or have to fit into Article 8 or Article 9. It’s more that our funds are on this journey to become more sustainable, which we want to continue. I think clients will see more of that focus on how we can make our funds more advanced in sustainability, perhaps reducing amount of carbon that they produce relative to conventional bond funds.

I think SFDR helps us fit into a framework, so that everyone else has to fit into what we were already doing if they want to sell in that type of area. So, this is really beneficial for us, and although it will have teething problems, I think overall it’s helpful for people to understand exactly what we are doing. It will be spelled out verbatim in the prospectuses, rather than in our own systems or in our presentations. I’m also hoping it will bring a little bit of a homogenous approach to it rather than every country doing their own thing. It’s about making it completely holistic, which I think is quite important for ourselves, but also for clients.

Berengere Blaszczyk: Mr. Sheasby, do you have a different view of what would do you think would be the impact of SFDR on the financial markets from an equity point of view?

David Sheasby: To me, it’s really about transparency and authenticity in terms of what SFDR brings to the market, and I’m really pleased that we’re moving in this direction. I think it will effectively shine a light on what asset managers are doing, and from the equity point of view, I think that’s very much the case.

Martin Currie has been integrating ESG for over a decade now, and for us, it’s led by the portfolio managers and analysts. As long-term investors, we put a big emphasis on engagement and active ownership. ESG is an essential part of how we invest. And so, part of what we’ve been doing as the regulations come out is working with the portfolio managers to think about how we formalise some of the things we’re already doing. The SFDR has really been about that—it’s not about a change in what we do, but about formalising what we do, thinking about the language that needs to go into the prospectuses, and how we actually articulate that in the prospectus system in a consistent way.

Basically, all of the Martin Currie strategies as they stand at the moment are categorised as Article 8 in regard to the criteria, so it’s really a reflection of what we already do. I think to David’s point, this is another step on the journey; it’s not the end point. There will be continued, further disclosures that will be required. And Article 9, for example, could potentially be seen as a different and more specialist category. Those kinds of things are very interesting in terms of how the market will develop, and we were very excited about the potential that this offers in Europe. As global investors, that will perhaps set a benchmark for other markets in terms of how they think about evolving their approach.

Berengere Blaszczyk: Mr. Janssens, I am curious to hear from you on how these ESG needs from underlying retail clients have evolved recently.

Guy Janssens: I think it’s a very important question because if you speak with clients regarding sustainability, green, SFDR and Febelfin labels, they all say they want more sustainable investments. But the most important question is the performance. The question is, if you integrate ESG, and if you make a transition of your offering from your products from Article 6 or 8 to 9, like what we are doing, will there be a negative impact on the performance, because we have to combine “be sustainable” with generating good performance?

We’ve seen last year, with the COVID-19 crisis, that ESG integration and Article 8 and 9 funds did very well, but not in all sectors or subsectors. So, in Europe and at BNP we are going to be more sustainable—which is very good—but clients still come to us for performance. There could be some doubts that there is a negative link between being sustainable and performance, and it is something we have to tackle. And we have to see about the engagement and the motivation of the clients. We are a little worried about the outlook and knowing clients like the idea of sustainable, but not necessarily at any price. So, we have to find good solutions that combine sustainability and good risk-return and performance. I’m convinced integrating ESG will lower risk in a fixed income portfolio and also improve risk-return in an equity portfolio, but this is longer term. Private banking clients, who I’m mainly working for in private banking, they don’t generally have a long-term view. There are some areas of the market—commodities/gold for example—where it’s really difficult for them to become Article 8 and 9 but they have had strong periods of performance.

Berengere Blaszczyk: Mr. Zahn, what are your thoughts from a fixed income viewpoint?

David Zahn: While we see an increase in demand for ESG investment solutions, performance remains key for clients in general. So, the integration of ESG, the engagement in fixed income, is incredibly important, but we also want to look at the risk-reward. The way we integrate the ESG is not by saying we’re going to buy best-in-class in everything. We rule out the very bottom of worst-in-class, but what we’re really looking for are companies and or countries that have acknowledged an issue with one part of the E or S—not usually the G—because if don’t have governance, the others don’t work. The key is if companies actually have a plan to start changing that. I think that’s where you can have an impact as an investor, but also you can generate alpha. It’s all about generating alpha within the constraints, but also trying to evolve companies and countries to move in the direction that will be better not only for them, but also better for investors.

Berengere Blaszczyk: On top of SFDR, we have a wave of other ESG regulations, and they don’t necessarily have the same the same criteria. So, as an asset manager, we have to adapt to a lot of different forces and stick to one theory of what we believe ESG is and adapt that to our clients, but that’s something that’s quite complicated to do sometimes. Who would like to discuss that a bit more, and how we are addressing not only SFDR but SFDR in the broader context of all ESG trends that we see around Europe?

Michelle Auger: Echoing what David Sheasby said earlier about the importance to remaining authentic and true to our own investment philosophy, this is our “north star” or what we need, what we believe, and what we stand for in terms of sustainability. We are aware there is going to be more regulation coming down the track, including in Asia, including in the UK. And in addition, as we’ve talked about, those labels in different countries are gaining traction in popularity. At Franklin Templeton, what we want to do in parallel with these developments is to continue the conversation with our clients to identify which will be the most important priorities for them, so we can continue to serve them.

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