Environmental, Social and Governance  

Hedge Funds in the U.S. and U.K. Are Told to Meet ESG Rule for EU Sales

Frances Schwartzkopff
Wed, December 22, 2021


(Bloomberg) -- Europe’s main investment management association says U.S. and U.K. hedge funds will need to meet a higher ESG reporting bar than many in the industry had expected, if they want to continue selling to clients in the EU.

The European Fund and Asset Management Association (EFAMA), whose members include BlackRock Inc., the asset management arm of JPMorgan Chase & Co. and Pacific Investment Management Co., said recent guidance from policy makers means hedge funds and private equity funds targeting EU clients need to state whether their actions -- in any part of their business -- might harm the environment.

The sub-clause in question -- the Principal Adverse Impact (PAI) rule -- is part of Europe’s Sustainable Finance Disclosure Regulation enforced earlier this year. Hedge funds based outside Europe had hoped that PAI only applied to the products they sold to European clients, not to their entire business. But Europe’s rulebook for environmental, social and governance investing is proving more far-reaching in its scope than many investment managers had anticipated.

Dominik Hatiar, EFAMA’s regulatory policy adviser for sustainable finance, says the stricter interpretation of European ESG rules follows discussions between his association and the European Commission.

“In practice, this would mean that the non-EU manager needs to publish its sustainability risk policy and make a comply or explain decision on the PAI regime,” he said. For managers with more than 500 employees, “the PAI reporting regime would be mandatory,” he said.

Many hedge funds outside Europe are already turning to their lawyers for help. Attorneys at Simmons & Simmons LLP and Dechert LLP have said they’re advising clients not to assume the stricter regulation will apply to them just yet, given the far-reaching consequences of doing so.

EFAMA also says it would still like clearer guidance from the European Commission. “We hope that this question will be further clarified,” Hatiar said. He expects the commission to provide more information in the form of an updated Q&A in the first half of next year.

A European Commission spokesperson who handles SFDR questions hasn’t responded to a request for comment.

Hedge Funds Hit by ‘Onerous’ ESG Rule Turn to Lawyers

John Ainger and Frances Schwartzkopff
Wed, December 22, 2021


(Bloomberg) -- An obscure rule covering environmental, social and governance investing in Europe has prompted hedge-fund managers in the U.S. and U.K. to turn to their lawyers.

At issue is whether they need to comply with one of the most complicated corners of Europe’s Sustainable Finance Disclosure Regulation. The sub-section in question -- the so-called Principal Adverse Impact rule -- requires investment firms to state whether their actions might in any way harm the environment. U.S. and U.K. hedge funds had thought the rule applied only to products marketed in Europe. But it now seems they must state PAI risks for their entire firm, even those parts that don’t target European clients.

“It’s a very difficult issue,” according to Lucian Firth, an attorney at the London-based law offices of Simmons & Simmons LLP who advises investment managers all over the world. PAI “is one of the most difficult and onerous parts of SFDR.”

Firth has spent much of the year helping international hedge funds and private equity firms comply with Europe’s sustainable finance rulebook, which was enforced in March. He says confusion around the Principal Adverse Impact clause -- the biggest item on a list of compliance areas that has non-EU managers scratching their heads -- has the potential to upend business models across the industry.

Caymen Funds

In anticipation of the requirement, some major hedge funds outside Europe -- specifically those with more than 500 employees -- are now looking into restructuring their operations to create separate legal entities that would protect the bulk of their business from the regulation, according to Firth.

“They want to keep marketing their Cayman hedge funds in Europe, but they don’t want to be forced into doing Principal Adverse Impact disclosures across the whole of their business because that is just too burdensome and they won’t do it,” he said.

Mikhaelle Schiappacasse, a lawyer at Dechert LLP’s London office, says the current guidance from Europe around PAI is unclear. Both she and Firth point to a Q&A document on the website of the European Commission as the origin of the confusion:

“Where an AIFM (alternative investment fund manager) from a third country enters the market of a given Member State by means of a National Private Placement Regime, that AIFM must ensure compliance with Regulation 2019/2088, including the financial product related provisions.” Until this statement by the commission, fund managers outside the EU had assumed compliance only stretched as far as products marketed to EU clients. Now, they’re not so sure.

A European Commission spokesperson who handles SFDR questions hasn’t responded to a request for comment.

European regulators, meanwhile, say there’s little doubt that fund managers outside the bloc are expected to live up to the PAI clause under SFDR, not just for individual investment products marketed to EU clients, but for their entire business.

According to Dan Nacu-Manole, a spokesman for the European Securities and Markets Authority, alternative asset managers based outside the EU are “required to file entity level SFDR disclosures.”

And fund industry representatives also suggest it’s risky to interpret the commission’s guidance in any other way.

“For me, it’s clear that the requirement applies to both entity and product related requirements,” said Marc-Andre Bechet, deputy director general of the Association of the Luxembourg Fund Industry, which represents Europe’s largest hub for fund managers. “Some people might not be happy about having to comply,” but “it’s not like you pick and choose.”

Dangerous Bet

For now, however, lawyers aren’t advising their hedge-fund clients to draw that conclusion.

“We think it would be dangerous” to do so, “without thinking through the implications,” Schiappacasse said. She points out that non-EU investment firms “will already be disclosing how ESG risks are integrated into the management of the particular project” under existing SFDR rules. “Why and on what basis would such disclosure be required across the investment manager’s non-EU activities?”

The view at Dechert is therefore that “it would seem more appropriate” to apply the approach taken with Europe’s Alternative Investment Fund Managers Directive, “which is that to the extent it relates to a product marketed into the EU, the product-based disclosure and reporting requirements apply, but not the broader firm level requirements.”

Firth said he hopes the European Commission will provide further clarification. Until that happens, firms should sit tight and not make any major adjustments to how they operate, he said.

“My large clients are concerned about this,” Firth said. “They don’t want to be doing PAI for all of their U.S. business and so they are watching this space very carefully.”

(Adds comment from Dechert LLP)

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