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Author: Greg Hotaling, Regulatory Content Manager, CSS, a Confluence Company

“I am superior, sir, in many ways.  But I would gladly give it up to be human.”  – Data

It’s an observation made by the fictional lieutenant commander in the 1987 pilot episode of Star Trek – The Next Generation.  But Data’s moment of reflection could also illustrate the thinking of E.U. authorities faced with global climate change.  As they push through a regulatory disclosure agenda for financial firms, despite significant gaps in ESG data, their implicit logic is that protecting the public must be the first and most urgent priority.

Data Challenges

Hence the first ESG disclosures for financial entities that must adhere to the technical standards of SFDR and the Taxonomy Regulation will be required beginning on 1 January 2023 – which is before much of the data they need will become available.  (For example, the reporting framework for corporates under the CSRD won’t require companies to report their relevant ESG data until 1 January 2024 at the earliest.) 

ESMA Executive Director Natasha Cazenave voiced the need for a human approach to this data challenge recently in a podcast with Eurosif (an industry partnership of sustainable investment stakeholders):

“We have this issue of lacking data for the moment. . ..  So we want to make sure that in that phase, everybody is responsible because, at the end of the day, we want to make sure that we maintain trust in the system.”

In practical terms, E.U. regulation on occasion provides some instruction relating to missing ESG data:

• For a financial entity’s website disclosure of principal adverse impacts on sustainability, under SFDR, the regulatory technical standards (RTS) require searching for missing sustainability data on a “best efforts” basis:

“Where information relating to any of the indicators used is not readily available, financial market participants shall include . . . details of the best efforts used to obtain the information either directly from investee companies, or by carrying out additional research, cooperating with third-party data providers or external experts or making reasonable assumptions.”

• For disclosure of a financial product’s investments in environmentally sustainable activities, in pre-contractual and periodic statements under SFDR and the Taxonomy Regulation, a relevant ESMA Q&A states that a failure to find the data needed requires indicating that no such sustainable investments were made.

But the lack of underlying ESG data is fairly widespread and, even when available, problems with its reliability, clarity, and comparability have plagued firms’ compliance efforts.  With the date of 1 January 2023 approaching, for ESG disclosure compliance under the RTS, data expert Chantal Mantovani has worked with firms scrambling to overcome these challenges, both from a compliance standpoint and as part of their investment strategies.  As Product Manager (RegTech and ESG Analytics) at Confluence, Mantovani hears these three problems mentioned most often regarding sustainability data:

• Inconsistency is often necessitated by reliance on different ESG data vendors.
• Ambiguity and the consequent need to make sense of that data for investors.
• Costs associated with procurement of the data.

While firms must contend with these issues, for the time being, the situation should gradually improve as the data vendor market consolidates, ESG regulatory disclosures produce more reported data, and firms become more accustomed to sustainability compliance.  Meanwhile, the most important factors for success for investment firms employing ESG data are described by Mantovani as follows: 

“The use of advanced technologies to seamlessly integrate ESG data and process into a broader company workflow can produce critical efficiencies.  This approach entails end-to-end, and if possible front-to-back office, ESG processes to allow consistency in building, monitoring, and reporting.”

It is by now acknowledged – including by regulators such as ESMA as cited above — that achieving perfect and comprehensive ESG data sets is currently impossible.  Investment managers are finding themselves needing the requisite regulatory knowledge and access to multiple data sources that will help them get over the line in these still-early days of sustainability compliance.  

While many firms have faced this challenge and have invested in systems and automation to streamline their efforts, other firms have yet to take those steps.  The latter group will face pressure as 1 January 2023 approaches, and they will devote resources to gathering and reporting their ESG information manually.  But from a longer-term point of view, it’s not too late for them.  Regulators (and even some investors) will perhaps be in a more forgiving mood as these first sets of ESG technical disclosures come due.  Looking back five years from now, any firm that chose to invest in ESG data analysis and reporting at this moment will still view that decision as a wise one.

The Regulatory Horizon

ESMA Executive Director Cazenave’s recognition of ESG data challenges, quoted earlier, is supported by ongoing regulatory efforts.  This includes the proposed improvement of ESG reporting standards.  The ISSB (International Sustainability Standards Board), an institution launched by the IFRS foundation at the U.N.’s 26th Climate Conference in Glasgow in November 2021, undertook a consultation on standards for corporate sustainability reporting that closed its comment period in July 2022.  ESMA saw fit to contribute comments, wherein it suggested that the ISSB work closely with the GRI reporting standards as well as with EFRAG (the European Financial Reporting Advisory Group) in formulating its standards.  Currently, the ISSB is analyzing the voluminous comments it received, responses to its surveys, and feedback from its extensive market engagement activities.  

For its part, EFRAG, which provides the European Commission with draft European Sustainability Reporting Standards (ESRS), launched its consultation for corporate reporting under the E.U.’s new Corporate Sustainability Reporting Directive.  After considering public comments, which were due on 8 August 2022 (and included a contribution by ESMA as well), EFRAG is expected in November to submit its first set of draft ESRS to the European Commission, which will consider them for adoption by way of delegated acts.

With sustainability reporting standards on a path to coalesce somewhat, regulators also have another target: ESG data and rating providers.  In early 2022, the European Commission and ESMA sought stakeholder feedback on the regulation of that industry.  By June, ESMA was able to present to the Commission the results of its call for evidence on the matter.  ESMA concluded that insufficient data, particularly about SMEs and non-listed companies, fundamentally impacts the usability and relevance of ESG ratings.  ESMA also noted:

• The low transparency of rating methodologies and data sources
• A lack of comparable and standardized data
• Misalignment on the definition of “ESG”
• Delays in updating or correcting underlying ESG data
• Ratings methodologies biased toward larger, listed, and U.S.-based companies

Suggesting possible future regulatory action, ESMA stated that the input it received may prove “useful for a possible assessment around the need for introducing regulatory safeguards for ESG rating products.”

By this time, the Commission was undertaking its separate consultation and call for evidence on the use of ESG ratings to assess that industry as well as the costs and appropriate type of “intervention at E.U. level” that may be needed.  By August, it could issue its summary report, which cited the overwhelming majority of respondents acknowledging problems in the ESG rating provider industry, as well as favoring regulatory intervention.  The Commission’s report also addressed the regulation of credit rating agencies to the extent they consider ESG factors.  Here, support for regulation was more muted, with most respondents favoring a non-legislative approach (in the form of guidelines or supervisory actions), and half of the respondents considered that current practices are satisfactory.  From these efforts, the Commission expects to adopt an initiative on ESG ratings in the first quarter of 2023.

Final Takeaway

Realistically, E.U. regulatory efforts addressing ESG data (or indeed such efforts anywhere else) face a substantial road ahead before they become effective.  In other words, investment managers will probably encounter a multi-year period in which some disparate, incomplete, and unreliable data will continue to exist in the marketplace.  Their current priorities, therefore, must acknowledge and reflect this reality.  Or, as Mantovani put it, “The path should be toward robust but flexible ESG data management and reporting.”

 ¹RTS (6 April 2022), Article 7(2).

 ²Questions related to Regulation (EU) 2019/2088 on SFDR, Sec. B, pp. 10-11.

 ³Credit ratings agencies are currently subject to disclosure requirements under the CRA Regulation.  Relevant guidelines, which include advice on transparency of any ESG factors driving credit ratings, were published in 2019 by ESMA (an institution which in fact was created, in 2011, for the original purpose of regulating credit rating agencies).

_{Disclaimer: The information contained in this communication is for informational purposes only. Confluence/StatPro is not providing, legal, financial, accounting, compliance or other similar services or advice through this communication. Recipients of this communication are responsible for understanding the regulatory and legal requirements applicable to their business.}

By Shane Flatman, Senior Product Manager  – Compliance, Reporting, and Services, CSS, A Confluence Company

The Sustainable Finance Disclosure Regulation (SFDR) is rapidly progressing towards the January 1, 2023 deadline, and the industry is in the process of managing and solving a variety of challenges. Here, we provide a brief timeline of the work that remains, discuss the challenges of the European ESG Template (EET) and ESG data, and the best ways to optimize data collection, quality and reliability.

An aggressive timeline

It was a busy summer for SFDR. In August 2022, the updated sustainability-related provisions under MiFID II and IDD Level 2 included target market elements, requiring sustainability preferences to be integrated with suitability assessments. 

Next, the European PRIIPs Template (EPT) will need to be adjusted for the new PRIIPs rules for September/October and the EET will need to be populated with the larger bulk of fields.

Starting in October/November 2022, EPTs will be circulated with the new PRIIPs methodologies. On the EET side of the equation, we’re going to see additional data being shared to satisfy SFDR disclosure needs.

Leading up to the January 1, 2023 deadline, the Commission will issue an evaluation of SFDR by December 30. SFDR Level 2 Regulatory Technical Standards (RTS) take effect on January 1, which will require firms to produce Pre-Contractual Disclosures and Article 10 Web Summary Disclosure Summaries at the product level. On the same day, non-financial undertakings will start disclosing full KPIs on taxonomy alignment under Article 8.

Firms will need to ensure that periodic disclosures will be ready by their first financial year-end in 2023, on the same day. Corporate-level disclosures are already in effect but will need to switch on monitoring capabilities for 2023 to generate next year’s disclosures.

Getting EETs off the ground

The EET “light,” which went into initial production in June, was to some degree an extension of the European MiFID Template (EMT), which should provide a fairly simple transition, either internally or with the existing manufacturers in the first release. The difficulty, however, comes when you need to fill in the full EET, which will come into play from October and November this year, and heavily rely on getting the required ESG data. Questions remain regarding the best sources of the data, and what providers can cover most of the assets.

First, one must consider the taxonomy elements and set up a target of alignment. The good news is that firms can set up their own targets. The bad news is that firms will need to get their investment data analyzed to fill the EET with the actual calculations, which can be difficult to do.

There are different approaches to fund of funds emerging also. Some investors want to collect data and analyze the portfolio themselves with their ESG providers.

Some asset managers are looking to build their own EETs based on underlying funds, which might be a quick win. However, issues may arise with the consistency of data. With tight EET deadlines, firms may run into delays if they rely too heavily on others to provide EET data.

In addition, most investors will need to buy Principal Adverse Impact (PAI) data for their SFDR requirements, for which EETs may be leveraged from underwriting providers as well, but perhaps only in the near term.

Three key data challenges

As with any of the SFDR regulations, the product manufacturer will always be responsible for sharing data related to the regulation with their partners, distributors, insurance record partners, and other entities. Hundreds of product manufacturers already have worked to provide their partners and distributors with the data they need to meet their MiFID II and IDD target market requirements. Still, several challenges remain.

With hundreds of new fields needed to populate the SFDR taxonomy, the first challenge is getting reliable and comprehensive data to fill those fields due to a significant gap that exists: ESG data does not tend to correlate well between providers, and some of the new taxonomy alignment fields are not even being reported. Technology, however, can help to bridge that gap.

The second challenge involves the many details, explanations and interpretations of data required, resulting in different methodologies used to make calculations.

Bridging the data gaps is the third challenge. EETs require data aggregation at the product level. Since products may be composed of many instruments, metrics also need to be aggregated. In addition, firms must be able to do EET reporting at scale across hundreds of complex financial products which can be difficult.

The general expectation is that the industry will meet SFDR regulations on a “best effort” basis in 2022 and that the availability and completeness of data will improve over time. At that point, data will likely be realigned and new data will become available. We’re also expecting to see insurance wrappers use EPT data (updated v2) from October and keep the existing v1 data in publication until December.

As EETs continue to be pushed out to the different data collection agencies and people who use EETs, many of the agencies will validate fields with FinDatEx, which will help to improve the process and clear up inconsistencies.

Other practical challenges

Interpreting some of the EET fields is one practical challenge that arises which may be addressed in a phased approach, starting with the MiFID II and IDD target market requirements in August, and continuing with the wider EET detail after that. However, that phasing in itself is causing some confusion.

Other challenges include the fact that some elements vary by country, and that some products will fall outside of the scope of the disclosures. However, the EET template still requires SFDR Article 6 products to be included, with a minimum amount of disclosure needed for all products. 

Some firms had been unsure of what fields were to be populated for tranche 1 of the EET in addition to the mandatory fields. These additional fields were driven by local distributors from mainly France, Austria and Germany. We feel that an open level of communication will be needed between the EET creator and the EET consumers as we near the tranche 2 delivery in the autumn, which will require many more fields.

Optimizing ESG data collection

Firms are beginning to break through their ESG data challenges and getting to a place where they can be truly satisfied and a looming greenwashing accusation threat no longer hangs above their heads. Insurers and distributors are also making strides in how they gather manufacturers’ ESG data for use in their own SFDR reporting.

Improving ESG data coverage will be a top priority for providers. Many firms clearly have identified that one provider will not be able to provide full data coverage. Using multiple data sources will likely be required to meet specific geographical, asset type or ratings requirements. By selecting several providers, firms can acquire different types of E, S, G, PAI or other specialized data that is closest to their investment universe. In addition, the use of multiple providers helps eliminate potential bias or risk of greenwashing accusations.

To obtain the largest coverage, over both issuance and financial instruments, technology that leverages machine learning and algorithms can enable firms to obtain the data in an automated and scalable process. This frees up analysts and research departments to monitor algorithms and verify the data to enhance coverage, quality and reliability.

Historically, the front office had done much of the work around ESG and sustainability, and that will continue. Going forward, increased alignment will be needed between the front, middle and back offices to ensure consistency across different sources in terms of timing and types of data – rather than all three operating in solos and reporting different information. 

Ideal solutions to help with EET

Accurate ESG analysis is based on good-quality investment data. Platforms such as Silverfinch from CSS, a Confluence company, can help investors or asset managers that have hundreds of fund inventories to collect data and look-through to their investments, which is a prerequisite to doing sound ESG analysis. 

In addition, aligning the middle to back offices can be best achieved by using a multi-source platform, such as Confluence’s Revolution, that provides the analytics the front office needs as well as delivers the data the middle and back offices need for downstream reporting.

But time is of the essence and the next few months will be intense. Companies supplying EPT and EET templates will want to be in a position to distribute underlying data to users of that data well in advance of their partners own deadline. With deadlines fast approaching, it is more important than ever that asset managers ensure they are ready to meet the SFDR ESG requirements.

_{Disclaimer: The information contained in this communication is for informational purposes only. Confluence/StatPro is not providing, legal, financial, accounting, compliance or other similar services or advice through this communication. Recipients of this communication are responsible for understanding the regulatory and legal requirements applicable to their business.}

Author: Shane Flatman, Senior Product Manager Compliance, Reporting and Services

Conversations with investment firms, management companies, fund administrators and industry attorneys have ramped up this summer as the industry prepares for the European Union’s (EU) new Packaged Retail and Insurance-based Investment Products (PRIIPs) reporting requirements by January 1, 2023.

Firms will need to adjust to new formats, content and calculations for preparing their Key Information Documents (KIDs) by January 1, 2023. Although many of the PRIIPs 2.0 requirements are already in play, one of the biggest impacts will be the “big bang” extension to include all domiciled Undertakings for Collective Investment in Transferrable Securities (UCITS) funds to be PRIIPs-compliant by the same date.

Needless to say, the next few months will be busy for the industry amid these and other simultaneous regulatory initiatives – such as the new ESG related MiFID II and Insurance Distribution Directive (IDD) requirements taking effect last month and the next wave of SFDR rules coming up, followed by periodic disclosures and the monitoring of data behind those disclosures – all of which will have a significant impact on operations resources, technology platforms and processes.

Key changes and timelines

Of particular note is the fact that PRIIPs KIDs will be published for UCITS products for the first time with new Regulatory Technical Standards (RTS) in place for existing PRIIPs KIDs. Other key areas of change include:

• Expansion of data requirements
• More detail around the appropriateness of benchmarks
• New complex calculations around performance scenarios
• Changes in how costs should be disclosed
• Insurance wrappers requiring the new EPT data
• European PRIIPs Template (EPT) changes and alignment with the PRIIPs KID 
• UK divergence on UCITS/PRIIPs

In addition, EPTs will need to be circulated with new rule data starting from September/October 2022.

Expansion of data requirements and calculations

PRIIPs will expand data requirements including those for net asset value (NAV), dividends, proxy, index, trial balance, and trade data. With PRIIPs, historical data will cover ten years to start. Funds that have been in existence for less than ten years will need to find proxies and benchmarks to do their calculations.

The requirements also stipulate more detail about the appropriateness of benchmarks. In addition, new complex calculations are driving firms to do parallel runs on new PRIIPs against the old requirements. 

In some situations, this can present a significant amount of change in the project figures as a result of changes in methodology. There are also changes around how the costs are to be disclosed, which will affect the figures the companies show for the Reductions in Yields (RIY), for example.

Version 2 EPT changes

The new EPT will include updated fields to align to the new PRIIPs RTS which comes into force on January 1 and will need to begin circulation from October/November 2022 to allow insurance firms to meet their January 1 PRIIPs obligations.

One key consideration is the fact that the EPT data should now align with the PRIIPs KID at all times. This differs from the previous approach whereby a fresh set of monthly or quarterly recalculations were pushed out to the insurance firms. Going forward, EPT data will be aligned to the PRIIPs KID and only updated when the PRIIPs KID is updated.

Discussion around performance displays

The new PRIIPs RTS requires that monthly past performance and performance scenario results should start to populate on the product manufacturers’ websites from January 1 and will need to continue for as long as history is available.

Currently, there is discussion around what date periods should be shown, how the results will be displayed, and for how long. A standard is beginning to emerge around annual performance results and index returns showing for 10 years on websites – similar to how UCITS KID looks like today – and that monthly performance scenario results should be available for as long as the history used to compute the calculation exists.

Another key discussion concerns the performance scenario table including date references to give investors a view of when a particular performance scenario was reached or experienced.

RTS and filing requirements

UCITS filings were straightforward since every regulator, whether in the home domiciled country or any cross-border jurisdictions, required the KIIDs to go to a local regulator either directly or via a local party.

However, PRIIPs KID is not as simple as each local regulator is still deciding on their specific requirements, even though a few are currently saying that they are not going to require the KIDs. 

The impacts of UK divergence 

The UK has taken a much different directive for PRIIPs KIDs which is affecting every UK domiciled fund that is sold to an EU investor or any EU product which is sold to a UK investor. For UK UCITS-like products, a UCITS KIID-like document is to remain in place for UK investors until 2026.

Firms will need to be aware of updates to requirements, able to feed the right data to the appropriate places, and be prepared to duplicate some effort in terms of PRIIPs filings and additional EPT versions.

In practice, this means firms will need to use dual PRIIPs templates and process dual KIIDs/KIDs in English for shared classes sold in both the EU and the UK. For UK-domiciled products, they will need to translate PRIIPs KIDs into non-English languages if they are selling cross-border in the EU.

In addition, the UK’s moderate performance scenario for UK PRIIPs KIDs, which underlies the calculation and disclosure of costs including the RIY, is now taken out of the specification but there is still uncertainty as to what will replace it. Therefore, it is likely companies will continue to use the moderate performance scenario method for the time being.

Moving forward with PRIIPs

With PRIIPs KIDs regulation deadlines fast approaching, it is more important now than ever that asset managers ensure they are ready to meet the compliance requirements. Your firm should be on track to onboard your providers in September, complete onboarding by November, and be fully tested and ready to go by early December. 

If not, then the first step is to figure out what’s stopping you from moving forward. Maybe you’re confused by the different PRIIPs interpretations. Or you haven’t had the time to assess your current reporting capabilities. Or you’re not sure your teams can handle the additional data and workload with everything else on their plates.

_{Disclaimer: The information contained in this communication is for informational purposes only. Confluence/StatPro is not providing, legal, financial, accounting, compliance or other similar services or advice through this communication. Recipients of this communication are responsible for understanding the regulatory and legal requirements applicable to their business.}