One issue is that the SFDR does not (yet) make clear whether transitional assets – for example, those that are in hard-to-abate sectors such as cement manufacturing – can qualify for inclusion in an Article 9 portfolio, nor whether it makes a difference if the activities concerned are, like cement production, eligible for alignment with the EU Green Taxonomy. For socially sustainable investments, firms don't even have a taxonomy to guide them, and are given considerable scope to determine which social outcomes qualify as "sustainable". (An EU social taxonomy is in development, but seems several years away from being finalised.)
At the same time, more recent guidance suggests that a fund should not use the word "impact" in its name unless the fund's investments "are made with the intention to generate positive, measurable social and environmental impact alongside a financial return". This is a pretty basic definition of an impact fund, derived from the GIIN's (Global Impact Investment Network's) widely used "core characteristics", but omits important nuances: for example, the requirement to mitigate negative impacts. Importantly, the EU guidance does not specify that only Article 9 funds can call themselves "impact funds"; indeed, many "Article 8" funds will rightly claim that they satisfy the GIIN requirements.
This lack of clarity is clearly unhelpful, and the UK has an opportunity to do a better job.
In its discussion paper last year, the FCA mooted various ways to define an impact fund, but none is without its issues. For example, they contemplate adopting requirements for "intentionality" and "additionality", which would be hard to police and, according to the FCA, would make its impact label only applicable to a "(small) sub-set" of SFDR Article 9 products.
On the other hand, and in contrast to the FCA's proposed labels for "transitioning" and "aligned" products, there does not appear to be any direct linkage between the FCA's proposed "impact" label and the forthcoming UK Green Taxonomy.
Some argue that a link between the Taxonomy (whether the UK or the EU version) and an impact label would be helpful to ensure that impact funds only make investments that are objectively determined to be "sustainable". There are, however, a number of issues with that approach. The most obvious is that there is, as yet, no European taxonomy to classify socially sustainable investments, no UK-specific taxonomy at all, and an EU environmental taxonomy that is not yet fully operational, with further developments already mooted.
But there are more fundamental issues with any direct link to the Taxonomy in minimum standards specified by the UK regulator and, in time, the EU. Most crucially, the data required to certify an activity as taxonomy-aligned may not be available. For investments in large EU companies, who will soon be obliged to report their taxonomy-alignment, that may be a short-term issue, but for investments outside the EU – and especially in less developed markets, where impact investments are sorely needed – the problem is unlikely to disappear in the foreseeable future.
And, even if data is available to make the taxonomy assessment, there will be important questions about whether an investment that is not currently taxonomy-aligned, but which is working towards it – or is otherwise making significant and measurable improvements in its operations to minimise its negative impacts – should be capable of inclusion in an impact-labelled fund.
Some will also argue that the approach that regulators adopt with regard to retail products should differ from that which is best suited to products only aimed at sophisticated institutional investors, who might have their own (dynamic and context-specific) views about what constitutes "impact".
These are not easy questions to resolve, but the BVCA has also urged the FCA to make sure that the rules are appropriate for private, blind pool funds that invest in illiquid assets. Such funds are well-placed to use their active ownership model to deliver positive outcomes, but their features also add to the complexity: for example, it may not be possible (or in investors' interests) to sell an asset quickly if it ceases to meet pre-defined portfolio composition rules.
The FCA's thinking is likely to have moved on significantly since it published its discussion paper in November and will, no doubt, take note of a more recent industry-led initiative to create a "Just Transition" label. It is disappointing that firms will not know the FCA's current intentions until the autumn – but if the final proposals manage to balance the complex competing considerations appropriately, the wait will have been worth it.
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