Asset Management: Compliance & ESG | New FSAN expectations on sustainability risk integration require most Norwegian asset managers to update SFDR disclosures

The Norwegian Financial Supervisory Authority (FSAN) has published detailed expectations for SFDR compliance following its review of sustainability risk disclosures across the Norwegian asset management industry. Whilst the majority of asset managers have implemented core SFDR requirements, FSAN has now provided more detailed expectations that go beyond what can be directly extracted from reading the SFDR or accompanying EU regulatory guidance. Consequently, most Norwegian asset managers will need to update their disclosures to be fully compliant with FSAN’s expectations.

Background

FSAN’s recent thematic inspection report[1] on selected investment firms and asset managers provides valuable insight into current market practices, as well as FSAN’s expectations and recommendations for SFDR compliance. In recent months, BAHR has also received further clarifications on FSAN’s expectations regarding sustainability risk integration.

Most asset managers have understood the core SFDR requirements. However, FSAN identified certain misunderstandings concerning the distinction between sustainability risk (outside-in perspective concerning how sustainability-related events affect investment returns) and sustainability impact (inside-out perspective concerning the investment’s negative impact on sustainability factors). Where this conceptual confusion exists, it has led to inadequate disclosures that fail to provide investors with meaningful information about how sustainability risks are actually integrated into investment decisions, and – potentially – greenwashing.

However, perhaps more importantly, even asset managers that have published comprehensive risk-based disclosures are unlikely to meet all the new expectations put forward by FSAN as these go beyond requirements that can be read directly from SFDR and ESMA guidelines. A review and update of existing disclosure is therefore likely warranted for most Norwegian asset managers to ensure compliance with disclosure requirements, as well as avoid any risk of greenwashing allegations.

SFDR Article 3: Entity-level sustainability risk disclosure

Asset managers must publish information on their websites about their policies for integrating sustainability risks in their investment decision-making process. The information must be easily accessible so that investors can easily understand how the company assesses and manages possible sustainability risks that may affect investment returns. Sustainability risk is assessed, in the same way as other traditional investment risks, from an outside-in perspective, concerning how external events or circumstances can negatively affect investment returns.

FSAN found that several firms do not describe how sustainability risk integration is operationalised, and generally require more detailed information than has been the general market understanding to date. The FSAN expects asset managers to comprehensively and understandably describe policies for identification, prioritisation and management of financially material sustainability risks. FSAN expects disclosures to include (without limitation):

What external information/data/analyses are obtained and from which sources
What assessments and analyses are made, and what methods and tools are used
How identified sustainability risks are managed and integrated through concrete measures such as portfolio adjustments, active ownership, or exclusions
How investors are informed about sustainability risk integration
Requirements for ongoing assessment and internal resources, competence and training

Key takeaway: FSAN has introduced more detailed requirements to sustainability risk disclosures, and asset managers must provide detailed, operational descriptions of their sustainability risk integration processes.

SFDR Article 6: Product-level sustainability risk disclosure

Under SFDR Article 6, asset managers must provide information in pre-contractual documentation about how sustainability risks are integrated in investment decisions for each individual fund. FSAN expects firms to, as a minimum, identify which sustainability risks are most relevant for each product, explain what measures have been implemented to reduce these risks, and assess the likely consequences of sustainability risks for returns. Asset managers must describe what assessments they make and how these are integrated into investment decisions, including investment committee meetings and decisions.

FSAN found significant weaknesses in current practices. Whilst several managers include sustainability risk assessments, there are very varying descriptions of how these affect investment decisions.

Key takeaway: Asset managers must clearly identify relevant sustainability risks for each product, explain mitigation measures, assess likely consequences for returns, and maintain strict separation between risk and impact perspectives. Additionally, for each investment, asset managers must ensure that sustainability risk is properly addressed at investment committee meetings and documentation.

SFDR Article 5: Remuneration policies and sustainability risk integration

SFDR Article 5 requires that asset managers publish how their remuneration policies are consistent with the integration of sustainability risks in investment decisions. There are no exceptions from this requirement. Registered alternative investment managers who may be exempt from remuneration scheme requirements must also publish such information.

Asset managers must provide clear explanations of how remuneration policies (and practices, even where no policy exists) support effective sustainability risk management, including how employees are incentivized, variable remuneration and applicable assessment criteria. References to internal policies addressing these matters are likely not sufficient.

Key takeaway: All asset managers must publish detailed explanations of how their remuneration policies and practices are aligned with integrating sustainability risks in investment decisions.

Distinguishing risk from impact in marketing material

As some firms confuse sustainability risk (outside-in perspective) with impact (inside-out perspective), legally required documentation and marketing material appear confusing and, in some cases, misleading. Also visual representations, such as logos and icons, use of green colour and various environmental-related imagery, typically capture attention and can be effective marketing measures. However, and for the same reason, asset managers must be cautious with such visual representations and clearly assess whether such visuals address sustainability risk or sustainability impact, and whether the use of such visuals are aligned with the sustainability profile of funds managed.

Key takeaway: Asset managers must clearly distinguish between sustainability risk and sustainability impact in all disclosures, ensure marketing materials accurately reflect the nature of SFDR obligations, and avoid misleading green terminology or visual representations.

BAHR comments

The new guidance from FSAN is welcome and provides useful insight into FSAN’s expectations. Although most Norwegian asset managers have presumably incorporated the required SFDR disclosures and adhere to the accompanying requirements, it is important to note that the level of detail required by FSAN is quite elaborate. The information required is quite operationally specific on how sustainability risk assessments are conducted and processed internally.

Asset managers should review current disclosures to ensure they meet FSAN’s operational requirements. Furthermore, sustainability risk integration and SFDR compliance should be adequately anchored in internal policies and procedures. For most firms, they have been implementing SFDR disclosures in compliance with the requirements deemed to be sufficient so far. Additionally, our assessment is that most firms do integrate sustainability risk in a manner appropriate based on risk assessment, complexity and scale of operations. However, there are improvement areas in terms of disclosures. The new expectations from FSAN represent an opportunity to strengthen existing disclosures and internal policies and procedures, rather than a fundamental overhaul of existing processes.

[1] Offentliggjøring av bærekraftsrelaterte opplysninger fra verdipapirforetak og fondsforvaltere – Finanstilsynet.no