Introduction

When providing advice, Everlake considers the adverse impact of investment decisions on suitability.

As part of our research and assessment of products, our advisors will examine the Product Provider’s literature to compare financial products and to make informed investment decisions about ESG products. Everlake always act in the client’s best interests and keep clients informed accordingly. The consideration of sustainability risks can impact on the relative cost, relative risk, and can both positively and negatively impact potential returns of financial products.

What do we mean by sustainable investing?

The Sustainable Finance Disclosure Regulation (SFDR) is a set of EU rules that aim to make the comparison of investment funds more understandable for investors on sustainability grounds.

Article 2(17) of SFDR defines the term sustainable investment as:

  • 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 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 such investments do not significantly harm any of those objectives,
  • And [provided] that the investee companies follow good governance practices, in particular with respect to sound management structures, employee relations, remuneration of staff, and tax compliance.

The issue with this definition of “sustainable investment” is that it leaves too much room for interpretation, especially when it comes to the “do no significant harm,” or DNSH, condition.

For the purpose of the DNHS test, a list of Principal Adverse Impacts (PAI) indicators must be considered. But regulators haven’t specified any thresholds, so the determination of what these should be has been left to the discretion of asset managers.

The PAI refer to a specific list of indicators that, at least in principle, allow investors to monitor the adverse impacts of the securities they invest in.

SFDR therefore focuses on a set of metrics designed for assessing the environmental, social and governance (ESG) outcomes of the investment process and places more emphasis on disclosure, including new rules intended to identify any harmful impact caused by the investee companies.

The directive is a component of the wider EU Sustainable Finance Framework which is backed by a broad set of new regulations that will apply across the EU. The SFDR goes hand in hand with the Sustainable Finance Action Plan which aims to promote sustainable investment, and a new EU Taxonomy to create a level playing field across the whole of the EU.

These measures are in response the landmark signing of the Paris Agreement in December 2015, and the United Nations 2030 Agenda for Sustainable Development earlier in 2015, which created the Sustainable Development Goals. The SFDR and other regulations are also aligned with the European Green Deal, which aims to see the EU carbon neutral by 2050.

These rules will force asset managers to reveal the differing levels of sustainability integration and focus of each investment strategy that they offer.

The regulation aims to create a more transparent playing field, partly to prevent greenwashing – where some financial firms claim that their products are sustainable when they are not.

Under the new classifications, a strategy will be labelled under either Article 6, 8 or 9 of the SFDR

  • Article 6 denotes funds that do not have a specific ESG objective and do not integrate any kind of sustainability into the investment process. These funds can include stocks that are excluded from ESG funds such as tobacco and coal producers and should be clearly labelled as non-sustainable.
  • Article 8, also known as ‘environmental and socially promoting’, applies “… where a financial product promotes, among other characteristics, environmental or social characteristics, or a combination of those characteristics, provided that the companies in which the investments are made follow good governance practices.”
  • Article 9, also known as ‘products targeting sustainable investments’, covers products targeting bespoke sustainable investments and applies “…where a financial product has sustainable investment as its objective and an index has been designated as a reference benchmark.”

An Impact investing range of strategies will be classified as Article 9. These include bespoke funds targeting climate change, renewable energy, the UN’s Sustainable Development Goals and specific themes such as gender equality.

The Sustainable Development Goals (SDGs) are 17 objectives for improving human society, ecological sustainability and the quality of life published by the United Nations in 2015. They cover a broad spectrum of sustainability topics, ranging from eliminating hunger and combating climate change to promoting responsible consumption and making cities more sustainable. The SDGs are the successor to the Millennium Development Goals (MDGs), eight objectives launched in 2000.

Article 9 funds typically focus on companies that provide positive solutions to the world’s biggest challenges like climate change. Solutions to environmental issues tend to be found in the industrial sectors. Article 9 portfolios therefore tend to be more concentrated at both stock and sector level with Industrial, technology, and healthcare being the most represented sectors.