CSSF's scrutiny of IFMs' sustainability-related practices

On 3 August 2023, the CSSF published a report on the implementation of sustainability-related provisions in the investment fund industry, based on on-site inspections initiated in 2022 and an off-site thematic review made during the second quarter of 2023.

The report summarises the CSSF's main observations and provides for the following reminders and recommendations for investment fund managers (IFMs) to improve their compliance with the EU sustainable disclosure and risk integration requirements, which have been gradually implemented since 2021:

1. Organisational arrangements: integrate sustainability considerations in portfolio and risk management, MiFID activities and related disclosures

1.1 Maintaining and adjusting sustainability-related obligations when portfolio management is delegated

The CSSF reminds IFMs that they:

• remain responsible for the disclosure requirements under SFDR even if they delegate the portfolio management function. They must either publish the required disclosures on their own website or ensure that the information is published on another website (for example, on the fund’s or portfolio manager’s website). If they choose the latter option, they must also provide a hyperlink on their website that directs investors to the webpage where the disclosures are available;
• must ensure proper initial due diligence, document it and monitor delegated portfolio managers, taking into account sustainability-related obligations, especially for funds disclosing under Article 8 or 9 of SFDR (eg. verifying integration of sustainability considerations into the portfolio managers’ investment decisions’ process); and
• must perform an independent and in-depth review of the performance of the methodology used by the portfolio manager on the investments selection through the acquisition of complete key performance indicators (KPIs) that match the net asset value calculation frequency of the fund.

1.2 Identification, integration and monitoring of sustainability risks

The CSSF expects IFMs to:

• establish, implement and maintain risk management and internal governance processes that identify and manage all the relevant sustainability risks (as defined under SFDR) for each fund under management (including article 6 funds), from the product design phase to the end of the product life cycle. A sustainability risk management process should include, among others, the relevant sustainability risks and indicators of the fund's risk profile, risk limitation system and reporting, as well as conducting stress tests and scenario analyses where appropriate. The integration of sustainability risks in the risk management processes should not be limited to verifying the compliance of the investment portfolios with the ESG-related investment restrictions disclosed in precontractual documents, but should rather require a holistic view of all relevant risks;
• have adequate checks and controls in place to monitor compliance with all ESG-related restrictions to be disclosed in precontractual documents; and
• document and report any breaches to the senior management, the board of directors and the CSSF.

1.3 Integrating and disclosing sustainability risks for discretionary portfolio management and investment advice

IFMs that offer discretionary portfolio management and/or investment advice must comply with SFDR and disclose how they integrate sustainability risks and their impact on their activities.

2. Website disclosure at entity level: publishing a statement on PAI considerations

The CSSF reminds IFMs that consider the principal adverse impacts (PAI) of their investment decisions on sustainability factors that they must publish a yearly statement by 30 June. The statement must cover the period from 1 January to 31 December of the previous year. The website disclosures must comply with the format and mandatory headings provided by the SFDR-RTS.

3. Precontractual disclosures: enhancing transparency disclosures

3.1 Clear and comprehensive information on the ESG features of funds

IFMs are expected to: 

• provide prominent, fair, clear and concise information on the environmental/social characteristics or sustainable objectives of their funds under management, in a way that investors can easily access and understand;
• refer to the categories of environmental objectives under the Taxonomy Regulation to clearly identify an environmental objective; and
• provide sufficient details and underlying assumptions regarding the environmental/social characteristics or sustainable objectives pursued by the funds to allow investors to make an informed investment decision.

3.2 Fair and not-misleading fund names in accordance with the fund's strategy

IFMs must ensure that the fund’s names:

• are aligned with the fund's investment objective and policy and with the principles-based guidance on fund names in the ESMA Supervisory Briefing; and
• do not use terms that are misleading or incommensurate with the ESG characteristics of the fund.

3.3 Disclosure of the methodology to assess sustainable investments

SFDR does not impose a single way of measuring sustainable investments, nor does it define the criteria to determine the key concepts of “contribution”, “do no significant harm” or “good governance”.

On that basis, IFMs are expected to disclose the methodology and assumptions they apply to assess sustainable investments and their alignment with these key concepts, in a clear and detailed manner to investors, as part of the pre-contractual and website disclosures.

3.4 Consistency of asset allocation with the binding commitments

The CSSF expects the fund’s assets allocation to reflect and match the fund’s environmental or social characteristics or sustainable objective it promotes and in line with the fund’s investment policy and, if applicable, the expected overall minimum proportion of sustainable investments.

3.5 Disclosing the consideration of PAI at product and not entity level

The CSSF noticed that most IFMs often refer in precontractual disclosures to the consideration of PAI at entity level, rather than at fund level. IFMs must provide detailed and relevant information on PAI consideration at fund level, and references to mitigation procedures.

4. Website disclosures at product level: enhancing compliance with the SFDR-RTS

4.1 Easily accessible disclosures in a dedicated section

IFMs must ensure that website disclosures are easily accessible, non-discriminatory, prominent, simple, concise, comprehensible, fair, clear and not misleading for investors, especially retail investors. The website disclosures should sit in a separate “sustainability-related disclosures” section of the IFM’s website along with other fund’ information or documents such as marketing communication.

4.2 Guidelines on website sub-sections

• Summary: IFMs must summarise in a dedicated section of their website the produce website disclosures for Article 8 and 9 funds. The summary section must not exceed two pages of A4 paper when printed. 
• Data sources and processing: IFMs should give relevant and detailed information in a simple language to allow investors to make an informed decision. CSSF recommends as good practice the use of tables to show data sources with inter alia ESG metrics, definitions and data sources. IFMS should also make sure their website disclosures match their ESG characteristics or objectives, indicators and investment strategy. 
• Limitations to methodologies and data: Such as for the data sources and processing section, IFMs should provide clear, relevant and detailed information in the "Limitations to methodologies and data". The CSSF encourages IFMs to use examples to illustrate their explanations on how any limitations to the methods and data used do not affect the achievement of the environmental or social characteristics promoted or the sustainable investment objective. 
• Engagement policies: The CSSF reiterates that relevant and detailed information in simple language allows investors to make an informed decision about the engagement policies applied. IFMs must explain on their website, depending on the fund's investment policy, how the engagement with investee companies is part of the investment strategy. 

5. Periodic disclosure: reminder to provide a prominent statement, comprehensive indicators, fund-level PAI, reporting on ESG actions taken and ensuring consistency

5.1 Prominent statement on where to find further sustainability-related information

The CSSF reminds IFMs that they must include a clear statement in the main body of their annual reports that directs investors to the relevant Annex of these reports to find more information on the environmental or social characteristics or sustainable investments of their funds, depending on whether they are Article 8 or Article 9 funds under SFDR.

5.2 Detailed information on how environmental or social characteristics or sustainable investment objective are met

SFDR-RTS require funds to disclose in periodic reports, how they met their environmental and/or social characteristics or their sustainable investment objective, by using relevant sustainability indicators that were disclosed in their pre-contractual disclosures. The periodic reports should present (i) the performance of sustainability indicators used for Article 8 funds and (ii) the overall sustainability impact for Article 9 funds.

The periodic reports should also provide information on:

• sustainability indicators used and their quantitative assessment;
• the limitations disclosed in the precontractual documents; and
• internal methodology (if used) and underlying assumptions.

5.3 Disclosing the consideration of PAI at fund level

As with the findings on precontractual disclosures, the CSSF found references in the periodic reports to the IFM's global policy applicable to all funds managed instead of specific PAI disclosure on the fund. IFMs should provide, where applicable, detailed and relevant information on the PAI considered during the reference period for each fund in their periodic reports, following the same qualitative and/or quantitative information as in the precontractual disclosures.

5.4 Actions taken during the reference period

IFMs must report on how they acted to achieve the environmental or social characteristics or sustainability objective of Article 8 and 9 funds, considering what they have precontractually disclosed. Periodic reports should include specific examples of actions and/or engagements related to the fund’s investments during the period and not to a global policy that applies to all funds managed.

5.5 Consistency with precontractual disclosures

IFMs must report various quantitative information in relation to the environmental or social performance of Article 8 or 9 funds in their periodic reports. This helps investors to compare the actual performance with the binding commitments made in the precontractual disclosures. IFMs must comply at all times with the binding commitments disclosed in the pre-contractual disclosures.

6. Marketing communications: consistency with fund documents, detailed disclosure on ESG credentials and hyperlinks

IFMs must:

• align their marketing communications with the sustainability-related information they disclose under SFDR, especially with the presentation of such information, the fund’s name, the investment objective and policy and the investment strategy. The marketing communication must be clear and specific to the fund promoted and should not downplay or contradict the precontractual disclosures;
• disclose sustainability information clearly and fairly in their marketing communications in a comprehensive and easily accessible manner, including when they refer to fund credentials such as ESG labels, ratings or certifications;
• name the entity that granted the credential, the fund that received it and the date of the award. A recommended practice is to briefly describe the entity having granted the credential and to provide a link to more information on the credential; and
• limit and maintain up-to-date hyperlinks in marketing communications. Hyperlinks should direct investors to the exact or relevant location of the information. Hyperlinks that redirect to all sustainability-related information of the fund or to the fund’s webpage are viewed as good practice.

7. Consistency and screening of portfolio with the fund's characteristics and objective

Funds' portfolio holdings have to reflect the name, the objective, the strategy and the characteristics of the funds as disclosed in their documentation. For Article 9 funds, the underlying assets have to qualify as sustainable investments, or serve specific purposes that are compatible with their sustainable objective, such as hedging or liquidity.

The CSSF expects IFMs to monitor investments of funds that apply exclusion policies and ensure their consistency with the investment policy. For example, an Article 9 fund that excludes only companies with a certain percentage of their revenues deriving from sub-activities linked to coal (eg. extraction of, transformation of or generation of energy from coal), without limiting the overall coal activity exposure, might be misaligned with the sustainable objective. Similarly, a fund that states in its precontractual documents that it will consider controversies such as cases of misconduct for assessing the sustainability of an investment, but does not explain clearly how they are handled or controlled, might not be transparent enough.

The CSSF is currently engaging on a bilateral basis with IFMs in relation to the observations made in the report and asking them to implement the necessary corrective measures where applicable. The CSSF also expects IFMs to address any shortcomings identified in the report and to follow the applicable regulatory guidance. The report is part of the CSSF’s supervisory priorities on sustainable finance, which reflect the EU’s ambitious legislative framework in this area.