Effective from 10 March 2021, VC and PE fund managers are facing new requirements stemming from an EU regulation on sustainability-related disclosures ("ESG Disclosure Regulation") which was published in the EU's Official Journal yesterday. The ESG Disclosure Regulation forms an important building block in the European Commission's Action Plan on sustainable finance. It will introduce new obligations for all VC and PE fund managers, including national sub-threshold managers, EuVECA managers as well as fully authorized AIFMs.
In 2015, the UN 2030 Agenda for Sustainable Development, having at its core 17 Sustainable Development Goals, and the Paris Climate Agreement were adopted. Both set ambitious goals to tackle, in particular, the consequences of climate change and resource depletion. To this end, the European Commission's Action Plan on sustainable finance published on 8 March 2018 aims at, among others, reorienting capital flows towards a more sustainable economy to cover a financing gap amounting to EUR 180 bn.
The ESG Disclosure Regulation is part of a series of legislative measures proposed by the European Commission in May 2018, also including a proposal to establish a unified EU classification system (called 'taxonomy') of sustainable economic activities and a proposal to regulate benchmarks for low-carbon investment strategies. While the taxonomy regulation is still subject to ongoing trilogue negotiations, the benchmark regulation was also published yesterday. Beginning from 10 December 2019, the latter will bring about a new generation of low-carbon benchmarks (the "EU Climate Transition Benchmark" and the "EU Paris-aligned Benchmark").
II. To whom does the ESG Disclosure Regulation apply?
The ESG Disclosure Regulation will, among others, apply to all types of VC and PE fund managers, i.e. registered sub-threshold fund managers, EuVECA managers and fully-authorized fund managers.
III. Which duties will fund managers need to comply with?
The new obligations for fund managers will range from publishing certain information on the website to an extending scope of pre-contractual information (e.g. in a PPM) and annual reporting.
The exact scope of applicable obligations varies depending not only on the regulatory status of the fund manager (as authorized, registered or EuVECA manager), but also on how the manager is classified with regard to its sustainability approach. The classification of the ESG Disclosure Regulation can be broken down into the following categories: managers managing conventional funds, managers managing ESG-promoting funds and managers managing sustainable investment funds.
Sustainable investment funds have as their core objective sustainable investments. ESG-promoting funds present, among other characteristics, the promotion of environmental or social characteristics, or a combination thereof, provided the companies in which the investments are made follow good governance practices. All other funds are considered conventional funds.
While some of the new obligations will apply to managers with respect to all funds regardless of classification, managers of sustainable investment funds and ESG-promoting funds will (depending on their regulatory status) have to comply with more obligations and higher standards.
Obligations applicable to fund managers with respect to all types of fundsAll fund managers will have to establish policies on the integration of sustainability risks in their investment decision-making process, publish them on their website and keep them up-to-date.
Fully-authorized fund managers will also have to revise their remuneration policies to reflect how those policies are consistent with the integration of sustainability risks. Such policies need to be published on the fund manager's website (and be kept up-to-date), however, in our view only to the extent it relates to the integration of sustainability risks.
Furthermore, and by means of a comply-or-explain mechanism, all fund managers will have to provide information on their websites on whether they consider principal adverse impacts of investment decisions on sustainability factors.
If they consider such adverse sustainability impacts of portfolio companies when taking investment decisions, a statement on their respective due diligence policies needs to be published on the website. The ESG Disclosure Regulation sets out the minimum content requirements to be met with regard to such statement, for example, a reference on the fund managers' websites to their adherence to responsible business conduct codes and internationally recognized standards (such as OECD and UNPRI).
In contrast, fund managers who do not consider such principal adverse impacts of their investment decisions on sustainability factors need to publish on their websites their reasons for not doing so.
In any case, publication of a statement on due diligence policies becomes mandatory if a fund manager exceeds certain thresholds. This applies in particular if the fund manager has on average more than 500 employees during a financial year. Same applies in a group context on a consolidated basis, i.e. if the fund manager is a parent undertaking and the group is a large group as referred to in the Accounting Directive (2013/34/EU). Absent any clear guidance, managers of private equity funds (as such funds hold majority shares in their portfolio companies) might be considered a group with all of their fund's portfolio companies.
Fund managers will also need to extend their pre-contractual disclosure documents (such as the PPM), whereas some obligations will only apply as from 30 December 2022.
Obligations applicable only with respect to ESG-promoting fundsAs regards ESG-promoting funds, all fund managers will need to publish and maintain additional information on their websites, such as a description of the environmental or social characteristics and information on the methodologies used to assess, measure and monitor the environmental or social characteristics.
Authorized and EuVECA fund managers will have to include additional pre-contractual disclosures and additional ESG-related specific annual reporting information (basically, a description in the annual report of the extent to which environmental or social characteristics are attained).
Obligations applicable only with respect to sustainable investment fundsAs regards sustainable investment funds, all fund managers will need to publish and maintain even more extensive information on their websites. Such additional information includes, among others, the index designated as a reference benchmark and certain explanatory information regarding such index and its application, or, if no index has been designated, an explanation of how the sustainability related objectives are attained.
Authorized and EuVECA fund managers will need to extend further the pre-contractual disclosures for sustainable investment funds as well as the annual reporting. The latter will need to include more technical sustainability related information, such as a description of the overall sustainability-related impact of the funds by means of relevant sustainability indicators or if an index has been designated as a reference benchmark, a comparison between the overall impact of the fund with the designated index and a broad market index through sustainability indicators.
IV. Next steps?
The ESG Disclosure Regulation will directly apply (i.e. without the EU member states transposing it into national law) from 10 March 2021. For the most part of the new obligations, the European Supervisory Authorities (ESAs) will develop more detailed information requirements by 30 December 2020. Such requirements in turn will need to be adopted by the European Commission in order to become effective.
As for the AIFMD, it is planned to amend its Delegated Regulation (EU) No 231/2013 (applicable to fully authorized fund managers only). For this purpose, the European Securities and Markets Authority (ESMA), which is responsible for fund managers, already published a final report for its advice to the European Commission on integrating sustainability risks and factors in the AIFMD on 30 April 2019. ESMA advises that fund managers should be required to assess sustainability risks that might have a relevant material negative impact on the financial return of an investment.
The publication of the ESG Disclosure Regulation is the next piece of the puzzle in the European Commission's Action Plan on sustainable finance. Even though its application still seems far in the distance, we strongly recommend market participants to start planning early in order to be able to fulfill one's obligations when the ESG Disclosure Regulation becomes applicable in March 2021.