With growing awareness of the risks of climate change and the role of responsible investment practices, recent years have seen a proliferation of new regulatory and NGO standards related to sustainable finance. Between these hard and soft law initiatives — including SRD II and the UN PRI signatory reporting initiative — many asset owners and managers across the globe now regularly report on their ESG investment and stewardship practices.
Soon, institutional investors in the EU and beyond will be implementing the next step in the evolution of this reporting — the EU’s ambitious Sustainable Finance Disclosure Regulation (SFDR). Among other things, the SFDR will introduce principal adverse impact indicators (PAIs), quantitative metrics for assessing investee companies’ adverse impacts, and granular reporting about the actions investors are taking to mitigate these impacts.
The quantitative adverse impact indicators are the centerpiece of and, for those affected by SFDR, a central challenge in complying with this new reporting regime. In addition to classifying their financial products and integrating the SFDR’s multiple new reporting mandates into their disclosure processes, affected financial market participants (FMPs) are understandably focused on the significant data availability issues associated with the PAIs. At the same time, investors would be well served to evaluate their stewardship practices and consider the critical, ongoing role they will play in SFDR compliance.
Glass Lewis has partnered with Arabesque to help FMPs understand and comply with these new metrics and requirements. Arabesque offers an SFDR Data Solution that ensures investors are able to meet the reporting requirements of SFDR. With the help of our team, we’ll get you set up with the raw data metrics that align with these new regulatory requirements.
Discover new insights for a smarter stewardship process. Connect with us to get started today.
The Role of Active Ownership in SFDR Reporting and Compliance
The complementary role of engagement and proxy voting was emphasized in the SFDR’s regulatory technical standards (RTS), which provide detailed instructions and templates for the new reporting expected under the SFDR. For example, the RTS specified that FMPs must disclose their engagement policies as well as policies relating to reducing principal adverse impacts.
At a more granular level, these disclosures will be expected to include — for each mandatory indicator — what actions the FMP has taken and planned to mitigate the adverse impact in question. The RTS explain that the “actions taken” column was added to the reporting template for each mandatory indicator “to give greater prominence to the engagement and other actions taken and planned by financial market participants” with respect to principal adverse impacts. As further explained in the RTS:
“Actions by financial market participants in relation to principal adverse sustainability impacts may include but are not limited to exercising voting rights as a shareholder, sending letters to or attending meetings with the management of investee companies, setting up documented and time-bound engagement in actions or shareholder dialogue with specific sustainability objectives and planning escalation measures in case those objectives are not achieved, including reductions of investments or exclusion decisions.”
Similarly, engagement and other stewardship practices will form a key part of new product-level disclosures for so-called Article 8 and Article 9 funds – those investment products that, respectively, either promote environmental or social characteristics, among others, or that have a sustainable investment objective. The SFDR mandates pre-contractual disclosures for Article 8 and 9 funds in which FMPs must explain: “What is the policy to assess good governance practices of the investee companies?” Periodic reports for Article 8 and 9 funds must also disclose their managers’ actions in furtherance of the funds’ E&S characteristics or sustainability objective by answering the questions: “What actions have been taken to meet the environmental and/or social characteristics during the reference period?” (for Article 8 funds) or “What actions were taken to attain the sustainable investment objective during the reference period?” (for Article 9 funds).
Engagement and proxy voting are obvious ways an active owner can promote good governance, further their funds’ E&S characteristics or investment objective, and encourage investee companies to mitigate their adverse impacts and associated risk to the companies’ long-term value. Moreover, given the expected difficulty of obtaining at least some of the PAIs at least in the near term, engagement can encourage more and more reliable PAI reporting by investee companies, a point reinforced through SFDR requirements that FMPs’ website disclosures for Article 8 and 9 funds address actions they are taking to overcome data limitations.
Solutions Glass Lewis Offers to Support SFDR New Expectations
In addition to its core proxy voting research, Glass Lewis offers a range of solutions to enable its clients to serve as active owners.
- Arabesque ESG Solutions. Glass Lewis is partnering with Arabesque, a global leader in ESG data and insights, to provide many of the world’s largest investors and public companies with data and environmental, social, and governance metrics to assess the performance and sustainability of publicly listed companies worldwide. In addition to featuring Arabesque’s ESG data in our Proxy Paper research reports, you can also get access to the SFDR Data Solution which offers raw data to meet 100% of mandatory metrics. Glass Lewis helps you get the coverage you need for all data requirements in the delivery method of your choice. Our partners at Arabesque have made it very easy to meet the SFDR requirement. Talk to our team today to get started.
- Aligning Proxy Voting with E&S Considerations or Objectives. Glass Lewis offers its clients a choice of fully-customizable thematic policies, including our Climate and ESG policies:
- Climate Policy. Introduced for the 2021 proxy season, our Climate Policy is guided by a framework established by the Task Force on Climate-related Financial Disclosures (“TCFD”) to ensure that shareholders vote to promote a transition to a low-carbon future, in a way that makes sense in the context of a company’s operations. The Climate Policy will also consider whether companies have set greenhouse gas emission targets and provided board oversight of climate or E&S issues. Particularly for funds with a carbon-reduction objective, the fully-customizable Climate Policy can help ensure that the fund votes in line with its sustainability objective.
- ESG Policy. Our ESG Policy supports investors with a heavy focus on promoting ESG-related disclosure and policies in portfolio companies. The policy has a strong stakeholder focus, and emphasizes issues including diversity and incentivizing sustainability through executive compensation. Managers of funds that consider social, as well as environmental, characteristics, or that have a broader ESG investment objective may want to consider whether our ESG Policy helps align their voting with their fund’s objective.
- Active Ownership Engagement Solution. Glass Lewis now offers an engagement solution that allows our clients to leverage the over 1000 engagement meetings we conduct with companies each year. By signing on to the engagement solution, our clients can collaborate with other investors to ensure their investee companies maintain best practices on issues such as climate change, greenhouse gas (GHG) emissions, sustainability reporting on social issues, board diversity, and executive pay. Detailed reporting on engagement meetings and outcomes can facilitate clients’ own reporting under SFDR, as well as SRD II and UN PRI.
- ESG Controversy Alerts. ESG Controversy Alerts highlight the most controversial ESG issues globally among the thousands of routine agenda items that appear on companies’ ballots each year. These succinct and actionable alerts, fully integrated into the Viewpoint platform, allow investors to sift through the haystack of daily vote decisions and identify material ESG and oversight concerns that require additional attention. Data and case studies from these alerts are published in an annual report that clients can leverage in their own stewardship reporting.
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While the SFDR, and PAI reporting in particular, is still being phased in, affected investors should make sure they are up to speed on what will be expected of them. In particular, we encourage affected FMPs to consider their stewardship practices and how they plan to meet the SFDR’s heightened expectations around engagement and disclosure of actions taken to mitigate adverse impacts at investee companies.
