The impact of new EU regulation on sustainable investment on Europe’s growing private debt market
What is the new regulation?
In March 2018, the European Commission released its “EU Action Plan for Financing Sustainable Growth”, a response to recommendations from the High-Level Expert Group on Sustainable Finance and with the intention of accelerating the realisation of the objectives set out in the UN’s Sustainable Development Goals and the Paris Agreement. The transition to a climate-neutral economy is not a simple one but, through updating existing regulation and aligning it across several jurisdictions, the EU hopes to: scale up sustainable finance to plug the current investment gap; ensure compatible cross-border markets to avoid fragmentation; achieve economies of scale; and maximise the impact of EU investment to support the industry.
While this is very much a work in progress, the EU has proposed three key pieces of legislation that will, hopefully, incentivise the private sector and channel investment into green and sustainable development. The first of these, the ESG Taxonomy Regulation, was introduced to create a unified green classification system for economic activities across the single market and with the aim of protecting private investors from the risks of “greenwashing” and will come into effect in a staggered manner from the beginning of 2022. The second, and perhaps the most important for the private debt industry, is the Sustainable Finance Disclosure Regulation (“SFDR”) which increases ESG disclosure requirements among financial institutions and should help to standardise sustainability performance, thus allowing investors to make informed decisions about their sustainable investments. The third and final of these is the introduction of new low-carbon benchmark indices to help investors compare the carbon footprint of their investments. The combination of these changes should help to foster a clearer ESG environment for investors and managers alike to make informed decisions about their sustainability efforts.
What does this mean for private debt funds like Kartesia?
The SFDR will be applicable to everyone as from this month. This upcoming disclosure regulation applies to a range of financial services organisations including investment firms, asset and fund managers and private banks, but there is no specific action that applies to private equity and private debt firms which means that regulation might be subject to interpretation. What we do know is that private debt is playing an increasingly important role in the financing of the European economy, so plays a key role in the future of European companies particularly as we emerge from the latest crisis.
The deadlines for the increased disclosure requirements are fast approaching and will mean that we need to assess the laws carefully. Since the end of last year, we have been involved in detailed discussions on the subject with our peers. We are also working in collaboration with a specialized consultant, INDEFI, to identify the articles of the regulations that would apply to Kartesia, to our different funds, and the various requirements arising from each of those articles. Two of the main articles to be reviewed by us and other private debt funds are articles 8 and 9 of the SFDR. Article 8 covers the funds that promote environmental (E) and/or social (S) characteristics, while Article 9 covers funds with “sustainable investment” as their objective. Depending on the article under which you classify your funds, your reporting requirements will be different, and the Taxonomy Regulation will add further requirements going further, evidence that the 3 key pieces of legislation are interconnected.
The good thing from a Kartesia perspective is that we have already started to implement actions to meet these stricter rules, including the appointment of a full time ESG employee to oversee the transition to this new legislation. Since 2018, we have already begun producing an annual CSR brochure to give investors and other stakeholders a clearer picture of our ESG activity but, from this year, will start publishing a more complete Sustainability report that will include disclosure requirements. From this month, we will also add a ESG KPIs in our quarterly reports to investors for all of our funds to ensure there are regular comparisons to be made on the sustainability of the portfolio and also to comply with SFDR requirements.