Fund Managers Brace for Europe’s New Anti-Greenwashing Rules

Rules that begin to take effect March 10 will require investment firms managing money in the European Union—many of which market funds that claim to focus on themes of environmental and social sustainability—to say whether they are reviewing the environmental and social impacts of their investments based on 18 metrics. The companies can also choose to explain why they aren’t considering those impacts, which range from greenhouse-gas emissions to gender pay gaps.

By June 30, money managers with more than 500 employees will no longer have that choice: They must publish a statement saying that they are considering the adverse impacts of their investments. Those that don’t meet the 500-staff threshold can opt out, but must still state clearly why they choose not to do so.

The good and ‘not so good’

Until now, institutional investors and asset managers could pretty much say whatever they wanted to with regard to sustainable investing, says

Bård Bringedal,

chief equities investment officer at Storebrand, Norway’s largest private asset manager.

“But with the new Sustainable Finance Disclosure Regulations,” Mr. Bringedal says, “we will have to document and report on these aspects in detail. That will help end investors separate good sustainable investing from the not so good.”

The financial-services industry has had a mixed reaction to the new rules. When the push for tougher standards started, there was pushback from asset managers and other critics arguing that the proposed regulations were too demanding and that ESG data to be used for the 18 metrics was unreliable. The critics said they were being required to gather sustainability data that either doesn’t exist or doesn’t rise to the standard of investment-grade use.

That opposition led the EU to delay the rules and to split them into two phases: the rules being introduced this month, and a more demanding set of rules that is expected to start taking effect in 2022 and 2023. Those rules say that by January 2022, all large investment houses, and smaller firms that opt in, must have published their sustainability policies and processes in detail, and be gathering sustainability data about the companies they invest in. Next, by June 30, 2023, the fund and asset managers must publish their data. From then on, that data must be updated every June 30.

The result for each fund and portfolio, regulators say, will be a snapshot that provides an overview of its environmental and social impact in each of the 18 metrics. The metrics vary in scope and complexity. While one looks at the female-to-male ratio of the boards of portfolio companies, for instance, another asks whether an investment is harming biodiversity. Answering that involves looking at a company’s operations. Damaging the environment could be in the form of interfering with the restoration of an ecosystem or disrupting protected areas, like Unesco World Heritage sites.

EU regulators originally proposed requiring data for 47 metrics. But the European Fund and Asset Management Association, or Efama, a lobbying arm of Europe’s investment-management industry, argued that such a lengthy list would only shift clients’ attention away from decision-useful information, and increase compliance costs without enhancing investors’ ability to make sustainable investments.

Opposition to the original proposal led to a reduction of the required reporting areas to 18. Areas that are no longer mandatory include deforestation and the risk of incidents involving child labor and human trafficking. There are now 12 required environmental metrics and six social, down from the proposed 21 and 26, respectively. Asset managers then must choose for themselves two additional metrics to report out of a possible 36 remaining.

“Having fewer mandatory indicators and more opt-in ones lets asset managers focus on the metrics that matter the most for investment decision-making,” says

Giorgio Botta,

regulatory policy adviser at Efama, adding that the implementation timeline is still tight but at least is now realistic. “Asset managers now have time to breathe,” he says.

In their final report, European regulators said they acknowledged that the trimmed down requirements “may better capture universal impacts applicable to all sectors and better reflect current data availability.”

Vanguard’s criticism

Vanguard Group was among big U.S. fund managers that criticized the draft regulations as originally proposed. The latest regulations are an improvement, a spokesman for the Malvern, Pa.-based fund company with more than $6 trillion in assets under management, now says.

“The revised technical standards strike a careful balance between disclosures that help reduce the risk of greenwashing and the challenges of data credibility, quality and availability for reporting,” says

Fong Yee Chan,

head of ESG strategy for Europe at Vanguard.

Many fund managers still worry about the lack of data being shared by companies and would have preferred if reporting requirements were first put in place for corporations. Yet the order makes sense to

Olivier Carré,

who heads up financial services at PricewaterhouseCoopers Luxembourg and has analyzed regulations for the past 20 years. Just because ESG data has yet to mature to the level of say, credit ratings, he says, that shouldn’t stop regulations like the EU is imposing.

“We shouldn’t let the fact that sustainability data is imperfect get in the way of making it better,” Mr. Carré says.

Complying with the regulations might not be easy, but noncompliance could lead to regulatory fines, court costs and bad publicity. National regulators can use fines, naming and shaming, and finally, withdrawal of licenses to enforce the rules, says

Julia Vergauwen

of law firm Linklaters.

Ms. Vergauwen emphasizes that asset managers should not underestimate the reputational damage they could suffer from breaking the rules, especially now that investors are paying more attention to ESG issues.

The new reporting requirements also matter beyond European investment firms. Most large New York and Hong Kong-based asset managers do business in Europe and sell funds in that market, and there will be pressure on them to make the same disclosures for their investments regulated outside of Europe, says

Sean Tuffy,

head of market and regulatory intelligence at Citi.

That view is echoed by many fund managers. “These rules already have a global impact outside of Europe,” says

Cathrine de Coninck-Lopez,

global head of ESG at Invesco.

Looking for harmony

The bloc’s rules could also spur other regulators to start harmonizing ESG reporting standards.

“European Union rules are often a starting point for Asia-Pacific regulators when considering their approach to sustainable investing regulation,” says

Michael Baldinger,

head of sustainability and impact investing at

UBS Asset Management.

Governments and investors in Asia increasingly put green-finance initiatives high on their agendas, and the EU’s rules could provide clarity on standards that will fuel ESG growth in the region, says Mr. Baldinger.

Morningstar

data show that Asia ex-Japan recorded $7.9 billion of net inflows into ESG funds in 2020, up from $810 million in 2019.

International alignment on sustainability data would go a long way to solving the misgivings of those who say that corporations aren’t yet reporting enough to fulfill the aims of the new regulations. Putting the onus on investment firms to demand this information from companies is a powerful way to bring about that data, says

Wolfgang Kuhn,

director of financial sector strategies at the nonprofit ShareAction.

“It is for the investors to ask these companies for the data because they are the owners of these companies,” Mr. Kuhn says. “If management won’t give it to you, you just vote them out.”

Mr. Holger is a Wall Street Journal reporter in Barcelona. Email him at dieter.holger@wsj.com. Ms. Negrin Ochoa is a reporter for The Wall Street Journal in Singapore. Email her at fabiana.negrinochoa@wsj.com.