Sustainable Finance: EU Regulatory Framework & ESG Investing Strategies

1. What is Sustainable Finance?

Sustainable finance is the integration of ESG factors into investment decisions within the financial sector, promoting long-term investments in sustainable economic activities and projects.  

Within the EU’s policy framework, sustainable finance is seen as financing that supports economic growth while minimizing environmental collisions. It also seeks to achieve the climate and environmental goals of the European Green Deal, while considering social and governance aspects. It further aims to ensure transparency on ESG related risks that could affect the financial system and to mitigate these risks through adequate governance of financial and corporate factors. 

2. ESG Investing Strategies

An ESG strategy aims to highlight the environmental, social, and governance factors that an organization shall deem fundamentally important to integrate into both current and future business operations. ESG Investing Strategies encompass various approaches that integrate ESG factors into investment decisions. The most common strategies are: 

• Negative Screening: Excluding companies or industries that do not meet certain ESG criteria, such as those involved in tobacco, weapons, or adult entertainment. This approach encourages leading companies to adjust their business models and improve practices to be considered by fund managers.  
• Norm-Based Screening: Ensuring investments comply with international legal standards and norms related to ESG issues, such as the United Nations Sustainable Development Goals. 
• Best-in-Class Investing: Selecting the top-performing companies within each industry or sector based on ESG criteria, regardless of the industry they operate in. 
• ESG Integration: Incorporating ESG factors into traditional data financial analysis and investment decision-making processes to identify risks and opportunities. 
• Active Ownership: Leveraging shareholder rights to influence corporate behaviour and enhance the sustainability of investments. This can be achieved primarily through direct engagement with the company or by exercising voting rights. 
• Thematic Investment: Selecting a specific sustainability issue and investing in indexes comprising companies which tackle that particular issue, such as renewable energy. 
• Impact Investment: Investing with the intention to generate significant ESG impact alongside financial returns. This often involves funding projects or companies with a clear mission to address specific ESG challenges (e.g. healthcare, sustainable agriculture). 

Each of the above strategies can be used individually or in combination to align investment portfolios with specific ESG goals and values. 

Contact us at info@salvusfunds.com if you require support with your ESG regulatory requirements and reporting obligations.

3. Regulatory Updates

Recent regulatory updates on sustainable finance and factors have significantly impacted the Markets in Financial Instruments Directive (MiFID) II, the Alternative Investment Fund Managers Directive (AIFMD), and the Undertakings for Collective Investment in Transferable Securities (UCITS) Directive.  

As far as it concerns MiFID II, the Delegated Regulation (EU) 2021/1253 has introduced a new definition of ‘sustainability preference’. As a result, investment firms must now consider clients’ preferences for sustainable investments when identifying target markets and making investment recommendations. The MiFID II enhancement also requires investment firms to incorporate sustainability risks into their risk management processes. This includes considering sustainability factors in suitability assessments and reporting how recommendations meet clients’ sustainability preferences alongside traditional financial objectives.  

From an AIFMD and a UCITS Directive perspective, both Directives now require asset managers to incorporate sustainability risks into their governance frameworks, including conflict of interest policies, investment due diligence, and risk management procedures. Along with that, fund managers must report if, and how their investment strategies align with clients’ sustainability preferences. 

These updates reflect the growing emphasis on sustainable finance and the EU’s commitment to achieving its climate and sustainability goals. Firms in the financial sector need to stay informed and compliant with these evolving regulations to meet both regulatory requirements and investor expectations. 

4. Product Classification under SFDR

The Sustainable Finance Disclosure Regulation (SFDR) is a regulation implemented by the European Union to enhance transparency in the financial market concerning sustainability risks and impacts. The SFDR requires financial market participants (FMP) and financial advisers, to disclose specific information about their approaches to integrating ESG factors into their investment decisions and advisory processes. SFDR categorises financial products and distinguishes disclosure requirements for each through three main articles: 

• Article 6 – Transparency of the Integration of Sustainability Risks 

This article pertains to financial products that typically do not incorporate sustainability into their investment process. FMP must disclose how they consider sustainability risks in their investment decisions and how these risks impact the returns of these financial products. Such products, often referred to as ‘grey’ funds, require both pre-contractual and website disclosures. 

• Article 8 – Transparency of the Promotion of Environmental or Social Characteristics in Pre-Contractual Disclosures 

It applies to financial products that endorse environmental or social benefits while maintaining strong governance standards. These so called ‘light green’ funds, must include detailed pre-contractual disclosures on their websites, and in regular reports. 

• Article 9 – Transparency of Sustainable Investments in Pre-Contractual Disclosures 

This article refers to any financial products, also labelled as ‘dark green’ funds, that have sustainable investment as their objective. This entails investing in economic activities that support environmental or social objectives. Similar to Article 8, such funds require pre-contractual disclosures, website disclosures, and periodic disclosures. 

Thus, Article 8 applies to funds promoting environmental and social objectives, which take more into account than just sustainability risks, as required by Article 6. Funds subject to Articles 8 and 9 are recognized as aligned with ESG criteria. However, funds subject to Article 9 are considered more advanced in their commitment to sustainability, positively impacting society. 

Final Thoughts

To conclude, the environmental impact of investments is a primary concern for global financial institutions and investors. Incorporating ESG factors is essential in the investment decision-making process across all areas of the finance sector. 

The SALVUS Regulatory Compliance team alongside the Risk Management team, are entrusted with the mission of supporting investment and financial institutions in their pursuit of regulatory compliance. Both teams stand ready to assist in creating and improving policies and procedures, easing the shift towards a more sustainable economy while keeping business operations uninterrupted. Our teams employ a sophisticated project management approach to accomplish a high standard outcome. 

On that account, SALVUS Funds in cooperation with the Institute for Professional Excellence (IforPE) has designed a self-study, self-paced course titled ‘Sustainable Finance: Regulatory Framework & ESG Factors in 2024’. The course is suited and recommended for professionals employed in entities regulated by the Cyprus Securities and Exchange Commission (CySEC) or the Central Bank of Cyprus (CBC). 

This online self-study program constitutes a comprehensive guide and grants 5 Continuous Professional Development (CPD) units counting towards the annual requirements of CySEC Advanced and Basic certification holders. 

Contact us at info@salvusfunds.com if you require support with your ESG regulatory requirements and reporting obligations or if you have any questions about our Sustainable Finance: Regulatory Framework & ESG Factors in 2024 course with IforPE.

#StayAhead

Should you be interested to read more about Sustainable Finance, MiFID Regulation or Investment Advice, please visit the selected articles below: 

• Providing Investment Advice & Portfolio Management under MiFID 
• The Roadmap to Sustainable Finance: ESG, EU Regulations, and Impact 
• ESG Regulations for European regulated entities 

The information provided in this article is for general information purposes only. You should always seek professional advice suitable to your needs.