MFSA Expectation in relation to ESG Requirements for Fund Managers

On the 16th December 2022 the Malta Financial Services Authority (MFSA) issued a letter addressed to Board Members and Compliance Officers of fund managers, self-managed schemes and third-country fund managers marketing their funds in Malta through the AIFMD national private placement regime, outlining their expectations in relation to ESG requirements (the “Letter”).

Under the European Commission’s Action Plan and Renewed Strategy on Sustainable Finance, the financial sector and financial regulators have seen a rally of initiatives in relation to the EU sustainable finance agenda and have been tasked with the role of unlocking and reorienting private investment to work alongside public funding in order the facilitate the transition to a carbon neutral economy and the achievement of the climate targets established in the European Green Deal.

Of critical importance for fund managers and the funds they manage is notably, the Sustainable Finance Disclosure Regulation (SFDR) which came into force on 10 March 2021 and the Taxonomy Regulation (TR) which came into force on 12 July 2020. Under the SFDR, fund managers, as one class of financial market participants, are required to provide increased transparency around ESG characteristics and the integration of sustainability risks at a product and entity level via: (i) pre-contractual documentation disclosures, (ii) website disclosures. and (iii) periodic reporting disclosures.

The Joint Committee of the European Supervisory Authorities (ESAs) was also mandated to develop Regulatory Technical Standards (RTS) which will now become the Level 2 regulation for these obligations and which will enter into force as from 1 January 2023.

The RTS works alongside the SFDR to ensure that disclosures about the degree to which investments are in taxonomy-aligned activities provide for full transparency about investments in fossil gas and nuclear energy activities, in particular on the proportion such investments in fossil gas and nuclear energy activities, in particular on the proportion such investments represent within all investments and in environmentally sustainable economic activities. The RTS also provide templates for how financial products that promote environmental characteristics (i.e. Article 8 products) and those that have sustainable investment as an objective (i.e. Article 9 products) should be presenting their pre-contractual disclosures and period disclosures. The ESAs also published a Questions and Answers (“Q&As”) document on 17^th November 2022 on the RTS for further guidance as to how the disclosures should be addressed in practice.

In addition, Delegated Acts amending the UCITS Delegated Directive and the AIFMD Delegated Regulation have now introduced additional obligations for fund managers to incorporate sustainability considerations in their risk management process, conflict of interest procedures and in the due diligence applied for the selection and ongoing monitoring of investments. These Delegated Acts started applying on 1 August 2022.

Looking at the local expectations in the context of sustainable finance, the Letter highlights how through an exercise carried out by the MFSA, it seems that the majority of local investment funds still fall within the category of Article 6 products (i.e. the products, which do not meet either the definition of Article 8 or Article 9 of SFDR are classified as ‘Other’, or ‘Article 6’ products.”), with only a small part of the local population of investment funds being classified as Article 8 or Article 9 products. The Letter highlights the efforts of the MFSA to carry out a desk-based review of the website disclosures used by fund managers and will also be issuing a set of high-level observations in this regard. The MFSA will thereafter be turning their attention to product level disclosures by adopting a risk-based approach. The Letter emphasises how the MFSA expects fund managers to strive towards transitioning to green, embracing sustainable finance and integrating this in their governance, risk management and investment policies. The Letter also hints that the MFSA expects that sustainability is incorporated within the culture of fund managers, in particular during Board Meetings.