This article was originally published in FundFire and is co-authored by Tristan Hackett, Director, Europe for BlueMark, and Christina Leijonhufvud, CEO of BlueMark.
Private fund managers may know their investors are increasingly embracing sustainable, impact or environmental, social and governance investment approaches – and that regulators across the globe are boosting focus on these strategies.
But managers now face a daunting new regulatory standard – stricter definitions of what constitutes responsible investment strategies that not only exposes these firms to compliance scrutiny, but also lets investors quickly assess whether a private fund meets the mark or is merely wrapping itself in green offering documents.
The U.S. is still taking its first steps on this path, with the Securities and Exchange Commission this year issuing a new ‘Risk Alert’ on ESG investingoutlining the early stages of examining investment advisers for “greenwashing.” But the major shift has taken place in Europe, a market most private fund managers can’t ignore – and that historically has paved the way on ESG issues in the U.S.
The European Union made a gravity-shifting move earlier this year by introducing formal requirements for the Sustainable Finance Disclosure Regulation (SFDR) that represent one of the most direct anti-impact washing efforts to date.
Our recent public statement on the SEC and SFDR warns managers that the earth has moved: “Regardless of which label an investor chooses to use – ESG, responsible, sustainable, impact, etc. – the message from regulators is clear that investors must have the right policies and practices in place to back up what they claim to be doing or the results they claim to be achieving.”
But managers should also recognize that these new standards have the potential to push existing impact management concepts and best practices into the mainstream. SFDR aligns with and reinforces existing impact investing frameworks and standards, like the Impact Management Project (IMP) and the Operating Principles for Impact Management (the Impact Principles). And its activation represents an important inflection point for the financial community broadly – and for the sustainable finance community specifically – in the fight against greenwashing and impact-washing.
SFDR is at heart an anti-greenwashing rule that requires all investment firms operating in Europe to categorize their investment products according to how they approach sustainability risks and opportunities. Investment managers with responsible investing products can choose among three different categories, each with specific and increasingly stringent disclosure requirements. These categories also roughly align with the IMP’s ABC classification framework introduced in 2015, which encourages investors to think more holistically about the positive and negative impacts of their investment decisions.
The first category, Article 6, is the minimum standard, which requires all financial market participants to disclose their policy on integrating sustainability risks and, in doing so, show how they do (or do not) “avoid harm” in their investment decision-making processes.
The second bucket, Article 8, is a higher standard for investment products that are actively promoting environmental and social characteristics, and it requires investment managers to disclose how they seek to “avoid harm” as well as “benefit stakeholders.”
The last grouping, Article 9, constitutes the highest standard, and is generally applicable to funds that have sustainable investment as their core objective. Article 9 requires investment managers to go a step further and disclose how they are actively “contributing to solutions,” particularly as it relates to climate change and other sustainability issues.
The higher bar for Article 9 funds represents a significant nod to many of the existing industry best practices for impact management. But whether an investor aims for a low bar or a high bar, the entire market benefits when there is a shared understanding of who is doing what and why.
Private fund managers should be thoughtful regarding which category they choose. While many investors may opt for the slightly less onerous Article 8 designation, we believe any self-described impact investors should be prepared to be accountable for the Article 9 designation.
Picking a category is merely the first step. Private fund managers will need the right tools and frameworks to get into compliance with SFDR. A good starting point for managers still unfamiliar with IMP and the Impact Principles would be to ensure they have developed a robust thesis that articulates the fund’s concrete ESG or impact objectives (while drawing on industry standards), and that describes how the investment strategy helps to achieve those objectives.
SFDR will not only change the game for managers in their compliance function. Initial data on the European investment universe shows just how far SFDR’s reach could be across managed assets in the market. A recent Morningstar analysis of more than 150,000 investment products found that 20.9% of funds are classified as Article 8 and 2.7% are classified as Article 9, representing $2.5 trillion in combined assets under management. Several of Europe’s biggest asset managers – including Amundi, BNP Paribas and Robeco – are reportedly planning to have at least 75% of their assets aligned with either Article 8 or Article 9 by the end of the year.
The investment management industry’s current impact-washing and greenwashing problem is in large part caused by financial market participants identifying themselves as “impact” or “sustainable” without any concrete evidence to back up such claims. SFDR was specifically designed to confront this problem by increasing transparency and accountability in the marketplace for sustainable investments.
But perhaps just as important is the regulation’s potential to encourage more investors to take the critical next steps, such as signing onto the Impact Principles. The rollout of SFDR could emerge as a turning point in the history of sustainable finance – the moment in which a broad swath of the market agrees on what is or isn’t sustainable and gets to work addressing urgent sustainability challenges.
I am writing this comment letter on behalf of BlueMark, a specialist provider of impact verification services for investors and companies. BlueMark was founded in January 2020 to meet the market demand for reliable, independent verification of the impact in impact investments, brought on by the rapid growth in this segment of the capital markets. To date, BlueMark has completed over 35 verifications for institutional investors of varying types and sizes on both their impact management practices (their systems, processes, and capabilities to manage impact as an integral component of the investment process) and impact performance (their reported impact results).
My own background includes 15 years at JP Morgan where I ran several risk management groups, including for the credit portfolio and emerging markets trading businesses, as well as the firm’s sovereign credit ratings advisory business. This experience provided me a first-hand perspective regarding how capital allocation decisions are made and the critical building blocks supporting development of new markets, including smart regulation, adoption of robust voluntary industry standards, and a mechanism to hold actors accountable to both.
Our view on the SEC’s role in climate change disclosures
Like many other investors and investor groups, we support the SEC’s intention to improve the consistency, reliability and quality of climate change disclosures by corporate issuers – and a variety of standards and frameworks exists for the SEC to draw from. We believe such a move is consistent with the SEC’s mission to 1) protect investors; 2) ensure fair, orderly, and efficient markets; and 3) facilitate capital formation.
However, this mission cannot be fulfilled with disclosures alone. Third-party assurance also plays an important role in driving market discipline and accountability, while also increasing the efficiency of asset allocation decisions. We have written about the importance of robust thirdparty verification in previous comment letters about related regulatory efforts. As we wrote in our comment letter to the IFRS Foundation regarding their proposal to create a Sustainability Standards Board (SSB):
“It is imperative that the Foundation allows for a range of service providers – beyond the traditional accounting firms – to provide external assurance services to verify the accuracy and completeness of sustainability reporting. We strongly believe that specialized firms like BlueMark bring an expertise and perspective to third-party assurance that extends well beyond the typical sustainability metrics to include the full range of qualitative and quantitative information necessary to form a complete understanding of sustainability practices and performance.”
We are pleased to have this opportunity to also contribute to the SEC’s efforts on climate change disclosures.
Addressing question #10 on the auditing and assurance of climate change disclosures
The growing threat of greenwashing and impact-washing—whereby what investors and companies actually do to address sustainability issues contradicts or falls short of what they say they do—is a major barrier to market confidence and the efficient flow of capital. According to the 2020 Annual Impact Investor Survey from the Global Impact Investing Network (GIIN), the biggest challenge facing impact investors over the next five years is “concerns about impact washing” (66%), followed by the market’s “inability to demonstrate impact results” (35%) and the “inability to compare impact results with peers” (34%). The survey also found that “comparability and validation of impact performance can address investor’s concerns regarding impact washing.”
We believe that smart regulation—which leverages voluntary standards and specialized, thirdparty impact assurance in addition to direct government regulation and policy—will help to solve for these challenges by bringing increased transparency, accountability, and discipline to the impact investing market.
The impact investing industry has already made some progress in adopting both robust voluntary standards and engaging third-party verification providers like BlueMark. For example, the Operating Principles for Impact Management (“Impact Principles”) were introduced in April 2019 as a set of best practices for how to integrate impact considerations throughout the investment lifecycle, from strategy design to portfolio management to exit. These Principles also include a requirement that all signatories seek independent verification of their alignment. Today, about 130 impact investors of various types and sizes, representing nearly $400 billion in combined impact-labeled assets under management, have signed onto these Impact Principles.
CDP, which runs a disclosure system that investors, companies, cities, states and regions use to manage their environmental impacts, also encourages submissions to include a third-party verification completed in accordance with recognized verification standards. According to CDP, more than 590 investors with a combined $110 trillion in assets have requested that companies disclose through CDP.
Other standard-setters are working on instituting similar verification requirements, including the Principles for Responsible Investment (PRI) and the SDG Impact Standards recently introduced by the United Nations Development Programme (UNDP). The impact investing market has matured rapidly in recent years as more investment managers adopt these standards, thereby helping protect asset owners and ensuring more capital flows to best-in-class impact investors.
We believe the SEC can help catalyze the adoption of these standards and frameworks by issuing guidance that encourages companies and investors to seek third-party assurance as a way to hold themselves accountable and make markets more fair and efficient. Such guidance could include:
Information on the types of disclosures required, including on both practices (processes) and performance (results)
Clarification of the relevant standards to which disclosures should be aligned (e.g., CDP, GRI, SASB, TCFD, etc.)
Encouragement for issuers and investment managers to engage third-party assurance providers rather than an internal audit approach to enable standardization and avoid conflicts of interest
Regular reviews of assurance processes and statements to ensure quality control, spotlight industry trends and proactively address any issues
While the immediate focus is on climate change disclosures, we believe it is imperative that the SEC cast a wider lens to encourage greater transparency and disclosure of other relevant ESG issues beyond climate change. Such issues may include diversity of board, management, and staff; pay ratios; political spending; etc. The SEC can also play an important role in signaling corporate responsibility to consider issues relevant to a broader set of stakeholders than shareholders alone, especially given the interconnectedness between climate change and other urgent social and economic issues.
Indeed, BlueMark’s verification services are designed with this broader stakeholder perspective in mind, directly responding to the needs of impact investors. Other types of investors–whether employing an ESG, sustainable or impact investment strategy–are also increasingly demanding this information as an input into investment decision-making. The number of investors that now seek company disclosures in alignment with SASB or TCFD are proof of this demand, and a sign of the growing importance of consistent and comparable disclosures in the years ahead.
We welcome any questions on the contents of this letter, and we look forward to working with both regulators and standard-setters to bring increased transparency and stability to financial markets.
Tideline Managing Partner Ben Thornley and BlueMark CEO Christina Leijonhufvud today issued a joint statement in response to recent regulatory developments in the U.S. and EU aimed at clamping down on greenwashing and impact-washing in the investment management industry.
Here is the full text of the statement:
Both the SEC in the U.S. and the ESA in Europe have begun to tackle the risk to investors of misleading impact and ESG claims. As a result, investment managers making impact and ESG claims need to be prepared for the business risk and liability implications if they are not confident there is consistency between claims and practices.
These efforts aimed at clamping down on greenwashing and impact-washing in the investment management industry are welcome developments and represent key steps towards improved labeling standards for ESG and impact investing products.
The introduction of Sustainable Finance Disclosure Regulation (SFDR) requirements in the EU and the SEC’s recent ‘Risk Alert’ on ESG investing reflect a growing call for investors to back up their impact and sustainability claims with evidence. Regardless of which label an investor chooses to use—ESG, responsible, sustainable, impact, etc.—the message from regulators is clear that investors must have the right policies and practices in place to back up what they claim to be doing or the results they claim to be achieving.
We at Tideline and BlueMark have been working with impact investors for nearly a decade to build credible impact management systems that can stand up to scrutiny. We believe that any investor that chooses to self-identify as an impact investor must have an impact management system to ensure that impact considerations are integrated into every phase of the investment process, from strategy design and due diligence to portfolio management and performance reporting.
This “do what you say” mantra is essential to preserving trust in impact investing, and is a big part of why Tideline launched BlueMark in 2020 as a provider of independent impact verification services. By bringing increased transparency and accountability to the impact investment market, we are driving efficiency, clarity and transparency in the manager/investor relationship and ensuring that impact promises lead to real impact results. We are encouraged by the work of financial regulators to contribute to improved transparency and accountability in ESG and impact investing.
While more work is still needed to harmonize around global standards, regulators are signaling that there needs to be a bar for what is considered a credible ESG or impact strategy. Independent verification can help investors meet that bar by providing third-party assurance of investor claims and practices. From the threat of new regulations to the difficulties of complying with existing regulations, investors will continue to need a resource to help mitigate and address both reputational risks and legal liability.
BlueMark, a Tideline company, provides independent impact verification services for investors and companies. With a mission to strengthen trust in impact investing, BlueMark’s services are designed to meet the need for reliable, third-party assurance of impact claims and practices. Learn more at www.BlueMarkTideline.com.
Tideline is a specialist consultant for the impact investing industry providing expert, tailored and actionable advice to clients developing impact investment strategies, products and solutions. Learn more at www.Tideline.com.