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Unsustainable risks? Regulatory climate change for AIFMD – October 2020

 

Welcome to the Faster, Higher, Further, MJ Hudson’s quarterly newsletter providing insights and updates on the latest trends in regulation, governance and fund services.

The Alternative Investment Fund Management Directive (“AIFMD”) was implemented in the EU in 2013, to regulate the alternative investment industry, chiefly as a result of the Global Financial Crisis. Fast forward seven years, and this directive is still evolving, but now with a new focus: sustainability.

On 8th June 2020, the European Commission published a draft delegated act1 which, if implemented, will increase the importance of sustainability in the AIFMD. The change comes from the wider EU Action Plan on Financing Sustainable Growth, which stems more broadly from the United Nations Sustainable Development Goals. It has the objectives of reorienting capital flows towards a more sustainable economy, making sustainability a core component of mainstream risk management and fostering transparency and long-termism2. The draft changes are expected to come into effect by the end of Q3 or the beginning of Q4, 2021. However, there are a number of factors that could disrupt this timeline, such as, of course, the impact of the COVID-19 pandemic.

What is actually changing?

  1. Due Diligence

After the execution of the delegated act, Alternative Investment Fund Managers (“AIFMs”) will be expected to factor in sustainability risks to their due diligence processes. Furthermore, if applicable3, AIFMs will have to update these processes in a way that is aligned with its principal adverse impact policies (due diligence policies describing how AIFMs take into account the principal adverse impacts which investee companies may have on sustainability factors).

2. Resources

At present, AIFMs are required to employ sufficient personnel, with the necessary skills to do their job. A further requirement will be for AIFMs to retain the necessary resources and expertise for the effective integration of sustainability risk.

3. Conflicts of Interest

AIFMs would have to ensure that, when identifying types of conflicts of interest, they include conflicts of interest that may arise as a result of the integration of sustainability risks in their processes, systems and internal controls.

4. Risk Management Policy

An AIFM’s risk management policy would be required to incorporate a procedure to assess the sustainability risk exposure of each Alternative Investment Fund (“AIF”), on top of its continued monitoring of market, liquidity, and counterparty risk exposures.

5. General Requirements

At present, the rules require AIFMs to establish, implement and maintain decision-making procedures and an organisational structure which specifies reporting lines and allocates functions and responsibilities clearly and in a documented manner. After the execution of the delegated act, AIFMs would be required to factor in sustainability risks when complying with these organisational requirements.

6. Control by the governing body, senior management, and supervisory function

Currently, an AIFM’s senior management is responsible for the implementation of the general investment policy for each managed AIF, and for establishing and applying a remuneration policy. These responsibilities would need to be updated to integrate sustainability risk.

Is it surprising?

Not really. A flight to sustainability is not out of the blue, with the importance of ESG and sustainability within the investment industry skyrocketing in recent years. In 2019, sustainable investment represented an AUM of $30.7 trillion in developed countries alone, representing an increase of 34% from 2016 and an impressive 68% increase since 20144. However, this trend is not industry specific: in fact, it is quite the opposite. The increased importance on sustainability is something that is valued highly by younger generations, with 62% of Generation Z preferring to buy from sustainable brands5, whilst 35% of Generation Z and 32% of Millennials wish to be meat free by 2021, compared to only 3% of the Silent Generation6. Members of this age group are currently at the early stages of their careers, or about to join the work force, and represent an important trend in changes to future work culture; their influence will only increase.

What is interesting, and perhaps more surprising, is that COVID-19 may have sped up the sustainability trend, despite us thinking it was already full speed ahead. Enforced, nationwide lockdowns have caused carbon emissions to plummet, and proved that drastic action can be taken when risk to public health becomes severe. Responses to COVID-19 have sparked optimism amongst climate scientists in our collective ability to tackle the climate crisis, whilst consumer trends also point towards a more sustainable way of life. A survey from Climate Assembly UK found that 80% of members surveyed7 believe that the measures taken by the government to help the economic recovery from COVID-19 should be designed to help reach “net zero”, and 93% said that, as the lockdown eased, the government and employers should encourage lifestyle changes to cut emissions. The movement can also be seen in investment trends, with 90% of wealth managers in a survey carried out by the Financial Times and Savanta8, stating that the COVID-19 pandemic would result in an increased interest in ESG investing. As discussed in our recent Vantage Point, there have been many uplifting stories in social media about acts of goodwill by companies, through the crisis, and, interestingly, independent financial advisers believe that investors will divest from companies that have not shown such support to their staff, customers, or communities, through the pandemic9.

To conclude, MJ Hudson believes this change is a step in the right direction, and one that is vital to keep up with ESG and sustainability pressures, but it could be the first of many changes in the AIFMD that pushes for environmental change, as the demand for climate justice continues to strengthen.

How can we help?

If you are thinking of launching an AIF that would fall under the AIFMD, you can appoint MJ Hudson to be the AIFM, and we will adhere to the high regulatory standards that the AIFMD upholds, including the implementation of new acts that come into force throughout the fund’s life. In an ever-changing regulatory environment, appointing MJ Hudson as the AIFM will allow you to focus solely on your duties of fundraising and fund deployment. Alternatively, MJ Hudson’s regulatory solutions department can provide you with advice in respect of new regulations, such as the regulation discussed above that will soon come into force.

 

[1] Amending Delegated Regulation (EU) No 231/2013 as regards sustainability risks and sustainability factors to be taken into account by Alternative Investment Fund Managers; https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/11960-Integration-of-sustainability-risks-and-factors-related-to-alternative-investment-fund-managers-
[2] https://ec.europa.eu/info/publications/sustainable-finance-renewed-strategy_en
[3] Where AIFMs consider principal adverse impacts of investment decisions on sustainability factors as described in Article 4(1), point (a) of Article 4 of Regulation (EU) 2019/2088, or as required by paragraphs 3 or 4 of Article 4 of that Regulation
[4] https://www.iisd.org/system/files/publications/sustainable-investing.pdf
[5] https://www.forbes.com/sites/gregpetro/2020/01/31/sustainable-retail-how-gen-z-is-leading-the-pack/#7d32ec0c2ca3
[6] https://www.plantbasednews.org/culture/-35-generation-z-want-meat-free-2021
[7] https://www.ft.com/content/50eb893d-98ae-4a8f-8fec-75aa1bb98a48
[8] https://www.ft.com/content/50eb893d-98ae-4a8f-8fec-75aa1bb98a48