An article from Bloomberg discussed potential business changes that some hedge funds are investigating in order to avoid being covered by the EU Sustainable Finance Disclosure Regulation (SFDR), which came into force this past March. According to the Directive:
Entities covered by this Regulation, depending on the nature of their activities, should comply with the rules on financial market participants [FMPs] where they manufacture financial products and should comply with the rules on financial advisers where they provide investment advice or insurance advice. Therefore, where such entities carry out activities of both financial market participants and financial advisers concurrently, such entities should be deemed to be financial market participants where they act in the capacity of manufacturers of financial products, including portfolio management, and should be deemed to be financial advisers where they provide investment or insurance advice.
FMPs are defined rather broadly and include, among other things:
an investment firm which provides portfolio management;
an alternative investment fund manager (AIFM);
a manager of a qualifying venture capital fund registered in accordance with Article 14 of Regulation (EU) No 345/2013; and
a management company of an undertaking for collective investment in transferable securities (UCITS management company)
Article 4 of the regulation, titled “Transparency of adverse sustainability impacts at entity level,” requires covered FMPs to publish and maintain on their websites:
- where they consider principal adverse impacts (PAI) of investment decisions on sustainability factors,
- a statement on the due diligence policies with respect to those impacts, taking due account of the size, nature and scale of their activities, and
- the types of financial products that they make available.
Where an FMP does not consider the adverse impacts of investment decisions on sustainability factors, the FMP must publish and maintain on its website clear reasons for why it does not do so, including relevant information as to whether and when they intend to consider such adverse impacts.
The problem, according to Bloomberg is that “U.S. and U.K. hedge funds had thought the rule applied only to products marketed in Europe. But it now seems they must state PAI risks for their entire firm, even those parts that don’t target European clients.” As a result, some of these funds are evaluating moving their headquarters out of the EU just to avoid having to make PAI disclosures. Lucian Firth, an attorney at the London-based law offices of Simmons & Simmons LLP said that many funds
“are now looking into restructuring their operations to create separate legal entities that would protect the bulk of their business from the regulation… They want to keep marketing their Cayman hedge funds in Europe, but they don’t want to be forced into doing Principal Adverse Impact disclosures across the whole of their business because that is just too burdensome and they won’t do it.”
I have to wonder if this is simply a game of “whack-a-mole” as my boss Liz calls it. With new ESG disclosure mandates coming from all directions and other jurisdictions, how long will it be before these funds must make some form of PAI-like disclosure? Does it make sense to incur the expense and disruption of moving entire businesses to other countries? Is the avoided expense of the PAI/SFDR disclosure enough to show a valid ROI on the cost of business reorganization? On its face, this seems like something of an overreaction.