Natalia Back, Associate Director, ESG Regulations, Private Markets, Manulife Investment Management.

Andrew Putwain: From an operational perspective, what are the top concerns for private markets investment management firms – and how do these challenges impact research strategies?

Natalia Back: Investors are interested in sustainable products, and private markets is well positioned to respond to this. But from the operational perspective, when we want to create new solutions to meet investor demands, we have to develop products within a specific strategy that will meet certain sustainable investing criteria.

The asset class, strategy and type of investments will determine the data and disclosure requirements that are necessary to measure and report on the sustainability performance of this new product. These requirements are our main concern because transparency in financial services is key to building trust with clients.

As sustainability regulations continue to evolve, investment firms like ours need to understand these developments and incorporate them into product development and the regulatory-related requirements that come with our investment strategies.

In the past, we would create a product for an investment strategy that applied our in-house ESG integration process, but in the current environment, we need to advance the strategy and also meet regulatory-related requirements. It's not sufficient that solutions meet the sustainable investing criteria the client is looking for, the solution should also align and comply with new regulatory requirements across multiple jurisdictions.

This creates three main points of difficulty. The first is that certain requirements mandated by these regulations do not necessarily serve the intended informative purpose. This means that some regulations create obstacles to comprehending the ESG strategy. For example, regulations are mandating certain disclosures that are not necessarily material to investors’ or clients’ interests, and this impacts how we can develop the product and strategy – since we now also have to meet those requirements.

There is a need to prioritise the quest for transparency through regulatory disclosure regimes. However, the regulator should also consider mechanisms to prevent an overflow of complex, incomparable disclosures that could ultimately overwhelm rather than inform. It's a cliché, but it's that idea that there is ‘no one size fits all’. Some regulations are too strict and or do not consider the current maturity of the market in terms of data availability and capacity for disclosure.

"Not all companies in scope of the SFDR are also in scope of the Corporate Sustainability Reporting Directive (CSRD) and have to disclose."

The second point is that data availability is a challenge. Disclosure obligations should avoid relying on future or aspirational data. We know, for example, the Sustainable Finance Disclosure Regulation (SFDR) relies on the fact that the sustainability reporting standards (ESRS) will require companies to disclose indicators that align with Principal Adverse Impacts (PAIs). This is great – we want interoperability and alignment between legislation, specifically in terms of the sustainability indicators and the metrics – but there are still challenges to solve.

One such challenge is that not all companies in scope of the SFDR are also in scope of the Corporate Sustainability Reporting Directive (CSRD) and have to disclose under ESRS. Also, we’ve had SFDR for three years, and the CSRD and the SRS are coming into force in 2024. This means that the timing of data availability is also a concern.

I want to acknowledge that steps are being taken in the European Union and other jurisdictions to improve reporting obligations, but policymakers should acknowledge that the data gaps will nevertheless persist for some time.

The final point of difficulty, especially for a global company like ours, is compliance with global and local regulations related to sustainability and the misalignment of requirements and prohibitions across jurisdictions. For example, when we think about Article 10 of SFDR, which requires certain information about the fund to be published on its website if the fund is also subject to regulation in the US, we see we encounter complexity because the US prohibits information about the fund being public.

So that is the complexity we need to consider in our daily operations regarding local and global regulations and interoperability that goes beyond aligning required metrics.

Andrew: What do differing frameworks – SFDR, SDR, the SEC’s – mean for individual investment spheres, and how does the lack of interoperability you mentioned impact your daily workload?

Natalia: Those who have been working with sustainability for a few years are already well-versed in the ‘alphabet soup’ of standards and frameworks. Policymakers, however, are also cooking up their own versions of this soup, with the addition of SFDR, SDR, and so on.

It’s important to understand that these regulations each serve different purposes – which is part of the difficulty. SFDR, for example, is supposed to be a reporting regime. This is key. It means that SFDR does not create labels or limit the use of funds’ names based on the minimal sustainability investment threshold. We know that some would argue that SFDR is a de-facto labelling regime, but this portrayal does not accurately represent its legislative intention. We also know that these frameworks are undergoing comprehensive consultation, so their intentions may change.

On the other hand, the SDR, which is the UK policy framework, is focused on labels and the use of names and targets that meet a minimum threshold of sustainable investment. This is similar to the US Securities and Exchange Commission’s (SEC) Funds names rule. This rule somewhat similar to the UK SDR – seeks to address fund names which may mislead investors about a fund’s investments and risks by applying the rule’s 80% investment policy requirement to any fund name with terms suggesting that the fund focuses on investments that have particular characteristics. If you name a fund “Sustainable” – you need to show an 80% minimum of sustainable investment.

"This prevalent focus on ensuring comparability by mandating disclosures without consideration of materiality has overshadowed the delivery of a meaningful disclosure."

For example, if you have a fund that’s called ‘sustainable’, you need to show 80% minimum sustainable investment. That's an important distinction; it helps understand the differences between SDR, SEC, and SFDR. They differ substantially in principle, scope, and how prescriptive they are. We hope to see global interoperability between the regimes, but we also understand that there is a difference between jurisdictions that the regulators and the industry need to acknowledge.

Another interesting point relates to materiality assessment and the double materiality in the EU – and ‘single materiality’, if you will, in North America – it’s important to understand the interoperability that we’re discussing. This discussion is connected to SFDR and ESRS: how regulations and jurisdictions create or define indicators and metrics that should be aligned. SFDR creates a complex regime because it has the PAIs, which are mandated and might not be material, but it also allows for bespoke indicators.

Of course, this is in turn challenging for workloads. I agree that we should have alignment between indicators and metrics, so I'm not challenging that – but I do believe that this prevalent focus on ensuring comparability by mandating disclosures without consideration of materiality has overshadowed the delivery of a meaningful disclosure.

ESG factors are inherently subjective. Returning to the workload point, delineating the distinctions and demonstrating the materiality of disclosures when preparing fund documentation and during the monitoring and reporting process has increased the workload and need for full-time professionals to address those challenges.

It’s not only that we’re collecting data we weren’t before, but that this data is not necessarily material. So, explaining what we’re doing to our portfolio companies – another form of engagement – is challenging. It’s the nature of the industry, though, especially in private markets; it’s difficult. In private markets, each strategy has its materiality of indicators. For this type of interoperability, it's important to advocate for a judicious balance between comparability and flexibility to not deter meaningful disclosures.

However, there’s a second type of interoperability – for example, fund label names that are connected to SDR. This is where companies will find complete, consistent, and comparable requirements. Interoperability, here, would mean a label means the same thing across all jurisdictions. It’s an area in which we’re looking for more regulatory support.

Andrew: What are the biggest effects ESG regulations and reporting regimes have had on private markets portfolios – both at the regional and global level? For example, are new doors being opened, or is selection increasingly restricted?

Natalia: The ESG regulations have had a positive but complex impact. The uncertainty around them is a challenge, and we do need to build internal capacity and often engage with external counsel on the topic.

With SFDR, we know it’s a piece of regulation that will be reviewed as time goes on – especially since it’s the first of its kind. For this reason, it’s important to be sure we’re consistently compliant, as developments continue.

In our organisation, we prioritised the application of sustainable investment classification and criteria in a consistent way across our products. That’s one way we ensured we had the same processes followed in all jurisdictions. Our in-house taxonomy is jurisdiction-agnostic.

"We see an increase in innovative solutions in investments in renewable energy projects or Climate Impact Funds."

On the administrative side, since we were already working with our in-house sustainable investing taxonomy before the regulations came up, we only had to review and consider jurisdictional adjustments, as concepts and requirements do change. Therefore, the regulation’s larger impact is the addition of new layers and processes to consider when developing a new product. It doesn’t necessarily change the way we do our analyses and create our strategies.

I think it’s overall been a positive effect, and, despite uncertainty and changes, these frameworks do support sustainability. They create more awareness and transparency around and within firms, as well as promote a product-specific approach to sustainability.

From a broader market perspective, investors and clients are now more aware of, or educated on, the potential risks and opportunities that can impact private markets portfolios beyond financial risk. These regulations and reporting regimes have influenced the way that investors and clients think about sustainability issues within their investments – beyond financial concerns. This means committing capital to funds that go beyond ESG integration, such as those with sustainability-related themes or focused ESG-related outcomes.

You asked about opening the doors for new investment opportunities – and, yes, that's another positive impact. We can see an increase in innovative solutions, for example, in investments in renewable energy projects or Climate Impact Funds. Not only do they have the potential to generate returns, but they also contribute to positive environmental and social impact.

Andrew: Private markets is an ever-developing sphere; how would you recommend that stakeholders stay on their toes with new changes, especially around ESG compliance?

Natalia: We often hear questions like: “how can you keep up with all this change?”. It’s especially topical for a global firm like ours, where we need to follow many, constantly evolving jurisdictions.

So, we created a legal and compliance centre of expertise (CoE) for regulatory change management, which enhances our management of changes to regulation and monitoring of new ones. The CoE is also responsible for considering the new regulatory thresholds and whether or not we meet them – another compliance challenge.

At the Manulife Investment Management level, specifically at the private markets, we have a multidisciplinary team of experts across private markets asset classes, I’m included, with a broad and deep sustainability expertise. These professionals are skilled to recognise and understand the jurisdictional changes around ESG.

"Engagement with industry organisations and trade associations is a must, as they not only provide updates and have training, but we also rely on these to advance our advocacy efforts."

Part of my role is to bridge these two groups, the Centre of expertise, and the Sustainable Investing Private Markets team by promoting a flow of information on legal and compliance matters related to sustainability.

In terms of how we can access information, we subscribe to all of the regulators’ bulletins and websites, as well as newsletters and publications that cover ESG. We also attend industry conferences and events that focus on ESG compliance – not limited to private markets. Public markets regulation can eventually become private market regulation. These events attract a range of stakeholders, from asset managers and institutional investors to policymakers and regulators, so they can provide valuable opportunities to network and learn from others in the industry.

Engagement with industry organisations and trade associations is a must, as they not only provide valuable updates and have webinars and training, but we also rely on these partnerships to advance our advocacy efforts. It’s important to ensure that regulations remain fit for purpose. For example, with the SFDR consultation, we'll be responding individually as Manulife, but we are also supporting industry associations in their responses.

Finally, external advisors, ESG consultants, and ESG-specialised law firms are also great partners. They can provide guidance on regulations – and, sometimes, they are close to specific jurisdictions, so they understand behind-the-scenes conversations you’re not privy to.

 

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