ESG funds adapt to prospect of tighter EU regulation

The EU Sustainable Finance Disclosure Regulation (SFDR) goes live in 2022 and will require ESG firms to assess how aligned their investments are with the sustainability activities within the EU Taxonomy.

Historically, most financial regulators have focused on financial risk. The EU Taxonomy will translate EU sustainability goals into a tool that both investors and organisations can use. This will help companies and issuers access green financing to decarbonise high-emitting sectors and grow low-carbon sectors.

The EU Taxonomy Regulation should enable investment fund managers to gather reliable, consistent and comparable sustainability related indicators from investee companies, incorporate this data into their investment decision and risk management processes, and fulfil their disclosure duties under the SFDR or other legislation.

It also provides further details on the content of sustainability related disclosures required in pre-contractual and periodic reports of environmentally sustainable investment funds, and investment funds promoting environmental characteristics.

For light and dark green funds the SFDR requires these firms to measure, against the taxonomy, the ESG implications of every asset in the portfolio.

Individual investments must be ranked according to their alignment, and an overall alignment score will also be given to the portfolio.

Eden Asset Management, the investment manager of the Eden Global Natural Resources UCITS Fund, which is classified as ‘Light Green’ ESG under Article 8 of SFDR, has already implemented these ESG considerations into its investment process and is a first mover within the global natural resources UCITS ESG funds management sector.

Eden conducts extensive due diligence and thorough reviews of ESG metrics of potential investments, as well as on an ongoing basis regarding monitoring of portfolio investments and ESG positions.

The fund has a portfolio with investments covering critical green energy metals, renewables/battery storage focused energy, recycling and agriculture - sustainable food production, inter alia.

We are seeing increased inflows in AUM into sustainable funds which we expect to continue.

Nicholas Boyd-Mathews, CIO, said that “the implications of the EU Taxonomy Regulation are that SFDR regulated funds will soon require a higher level of ESG commitment, reporting and governance to be implemented for investee companies to attract and maintain investment, which can be applicable to both the equity and debt/bond components of the capital structure.

"As the SFDR EU Taxonomy Regulation becomes more defined across Europe we expect to see these standards become more widespread and anticipate similar standards and ESG regulations being implemented within Australia in the future.”

This regulation will cover all sectors and companies of all size. Within the Australian resources sector, we are already seeing large cap companies moving to position themselves in a more ESG friendly manner.

Smaller companies are still currently lagging, largely driven by a lack of awareness or resources, given they are often developing a single asset with limited capital. However, by committing to address sustainability and ESG now, they will likely open additional avenues to seek green financing going forward.

The challenge now is that the ESG ratings agencies and data sourced from external information providers is inconsistent across platforms, and there is a large data gap at the smaller end of the market. Unfortunately there is a lot of greenwashing occurring in the smaller end of the market, so a higher level of due diligence and examination of ESG data is required.

Matthew Hall, investment manager of the Eden Global Natural Resources UCITS Fund, stated that “where coverage is available for larger capitalised companies, we utilise ESG data from major established and leading external ESG data providers and further investigate any areas of concern, which will be discussed with the respective companies.

"Where there is no ESG data available for smaller companies, we will conduct our own thorough due diligence, as well as engaging ESG specialist consultants to assist us, to establish specific ESG risks, and companies which are considered not to meet appropriate ESG standards will be excluded.

"We provide direct guidance and road maps to senior management teams on any areas of improvement to assist them to increase ESG standards, and further define the company’s sustainability goals over time.”