AIF and UCITS integration of sustainability risks and factors

Summary

  • Legislative measures requiring integration of sustainability factors and sustainability risks into UCITS and AIFMD regimes will apply from 1 August 2022.
  • This follows ESMA technical advice requested by the European Commission. You can read our August 2020 briefing on the background leading up to the ESMA final report here.
  • Compliance with these requirements should be assessed within each AIFM's and UCITS' existing risk management and governance framework and should be aligned with the AIFM's or UCITS' analysis for compliance with disclosures under the Sustainable Finance Disclosures Regulation (SFDR).

Changes to the UCITS Directive and AIFMD

On 2 August 2021 Level 2 legislative measures were published in the Official Journal of the EU:

The requirements in these new Level 2 measures will apply from 1 August 2022.

For AIFMs, UCITS management companies and self-managed UCITS the implications will mean looking through a sustainability lens at risk management procedures and processes, investment decision making processes, organisational structure and resources, governance, oversight, reporting and conflicts of interest management.  Boards of externally managed AIFs and UCITS will need to consider the extent of their responsibilities in relation to integration of sustainability risks and factors and those of the AIFM or UCITS management company.

Sustainability risks

A “sustainability risk” is defined by SFDR as “an environmental, social or governance event or condition that, if it occurs, could cause an actual or a potential material negative impact on the value of the investment.”

AIFMs and UCITS should assess not only all relevant financial risks on an ongoing basis, but also all relevant sustainability risks that, where they occur, could cause an actual or potential material negative impact on the value of an investment. To ensure that internal procedures and organisational arrangements are properly implemented and adhered to, it is necessary to clarify that processes, systems and internal controls of AIFMs and UCITS reflect sustainability risks, and that technical capacity and knowledge is necessary to analyse those risks.

Sustainability factors

“Sustainability factors” are defined by SFDR as “any environmental, social and employee matters, respect for human rights, anti-corruption and anti-bribery matters”.

Sustainability factors will need to be taken into account by AIFMs, UCITS management companies and self-managed UCITS as part of their duties towards investors. 

Due diligence in investment decision

Pursuant to SFDR, AIFMs and UCITS that opt-in or are obliged to consider principal adverse impacts of investment decisions on sustainability factors, must disclose how their due diligence policies take those principal adverse impacts into account. Sustainability risks must be taken into account in the process of selecting and ongoing monitoring of investments.

Resources

AIFMs and UCITS must retain the necessary resources and expertise for the effective integration of sustainability risks.

Conflicts of interest

To maintain a high standard of investor protection, AIFMs and UCITS should, when identifying the types of conflicts of interest which may damage the interests of an AIF, include conflicts of interest that may arise as a result of the integration of sustainability risks in their processes, systems and internal controls. Those conflicts may include conflicts arising from remuneration or personal transactions of relevant staff, conflicts of interest that could give rise to greenwashing, mis-selling or misrepresentation of investment strategies and conflicts of interests between different AIFs or UCITS managed by the same AIFM, or UCITS management company, respectively.

Risk management 

AIFMs and UCITS shall assess and manage exposure to sustainability risks in the same way as other risks such as market, liquidity, counterparty and operational risks.  Procedures for this should be incorporated into the risk management policy.

Organizational structure 

Sustainability risks should be taken into account in the AIFM's and UCITS' decision-making procedures and organizational structure, including in reporting, compliance and record-keeping processes.

UCITS and AIF sustainability integration checklists

We are preparing checklists for UCITS and AIFs to assist planning for, and compliance with, these amendments to the AIFMD and UCITS Directive. Contact a member of the ALG Asset Management & Investment Funds team for further information.

Date published: 26 August 2021