In July 2018, the European Commission directed ESMA to provide technical advice on how to amend the UCITS Directive (2009/65/EC) and AIFMD (2011/61/EU) to integrate sustainability risks and sustainability factors into the two regimes. On 19 December 2018, ESMA issued a consultation paper (the "Paper") containing its proposals.
The proposals reflect a range of high-level principles based changes to both directives aimed at meeting the European Commission's objective of integrating sustainability risks into investment decision processes.
In the Paper, ESMA explains that "sustainability risk" can be understood as "the risk of fluctuation in the value of positions in a fund’s portfolio due to ESG factors". It cites ESG factors as follows:
(i) Environmental - issues relate to the quality and functioning of the natural environment and natural systems;
(ii) Social - issues relate to the rights, well-being and interests of people and communities; and
(iii) Governance – issues relate to the governance of companies and other investee entities.
ESMA proposes text changes to the UCITS Directive and AIFMD across six areas, namely (i) general organisational requirements; (ii) resources; (iii) senior management responsibilities; (iv); conflicts of interest; (v) due diligence requirements; and (vi) risk management.
Most significantly under the proposals, UCITS management companies and AIFMs will need to:
- Consider sustainability risks when selecting, monitoring and understanding the investments it makes; and
- Consider sustainability risks stemming from their investments (along with all other relevant risks such as market, interest or credit risk) in their risk management framework,in each case in a way and to the extent that is appropriate to the size, nature, scope and complexity of their activities and the relevant investment strategies pursued.
Among the Paper's questions posed is whether stakeholders agree that it is correct to amend the UCITS Directive and AIFMD to require UCITS management companies and AIFMs to take into account sustainability risks and factors when selecting, monitoring and understanding investments based on a high-level and principles based approach or whether the legislation should be changed in a way that reflects a more granular approach.
Interestingly, ESMA does not ask if stakeholders agree that it is appropriate for legislation to mandate that sustainability factors should be considered in the investment process or how that may be expected to operate in practice.
ESMA are seeking feedback on the proposals up to 19 February 2019.