FCA sharpens oversight: The UK regulator is finalising new rules on non-financial misconduct, extending its scrutiny beyond the office and setting clearer standards for personal and workplace behaviour.

Manager accountability grows: Managers must actively prevent bullying and harassment, or risk personal liability under the Conduct Rules if they fail to act.

Culture change expected: Firms can no longer dismiss poor behaviour as business as usual, with the FCA aiming to shift the conversation from 'Sexism in the City' to 'Accountability in the Office'.

Links:

https://www.ft.com/content/2e4df2fe-d2ae-46aa-bd00-d031a037bb44

https://www.traverssmith.com/knowledge/knowledge-container/new-fca-guidance-on-non-financial-misconduct/

The EU's sustainability omnibus is finally passed: The European Union has finalised its dramatic reforms to sustainability reporting rules, hitting fewer private companies and relaxing several related obligations.

The UK confirms a cautious roll out: The UK’s sustainability reporting standards have been finalised, but mandatory rules are being developed that focus on proportionality and cost-benefit analysis – with more news for large private companies expected later in 2026.

Sustainability remains a priority for rule makers: Both the EU and UK remain committed to sustainability as a policy priority, but now openly discuss burdens for companies as well as benefits for society.

Links:

https://www.consilium.europa.eu/en/press/press-releases/2026/02/24/council-signs-off-simplification-of-sustainability-reporting-and-due-diligence-requirements-to-boost-eu-competitiveness/

https://www.traverssmith.com/knowledge/knowledge-container/travers-smiths-sustainability-insights-sustainability-reforms-lack-a-convincing-theory-of-change/

https://www.gov.uk/government/publications/uk-sustainability-reporting-standards-uk-srs-s1-and-uk-srs-s2

https://www.fmg.ac.uk/isf/publications/special-papers/do-climate-disclosure-mandates-help-decarbonise-economy

https://www.traverssmith.com/people/simon-witney/

https://www.traverssmith.com/knowledge/knowledge-container/travers-smiths-sustainability-insights-why-less-might-be-more/

https://www.gov.uk/government/consultations/exposure-drafts-uk-sustainability-reporting-standards/outcome/government-response-to-the-consultation-on-uk-sustainability-reporting-standards-web-version#:~:text=a%20world%20leader%20for%20sustainable%20finance

Wealthy individuals targeted: In Europe, policymakers and larger private fund managers are adapting rules and processes to attract more high-net-worth investors, while acknowledging that managing investor protection rules is essential.

FCA aims to simplify categorisation: The UK's regulator is proposing a more flexible, judgment-based approach to opting up retail clients, replacing rigid thresholds but stressing the need for robust assessments and proper due diligence.

Firms must maintain standards: As individual investors become more prevalent in private markets, compliance processes are essential – requiring significant investment but promising lasting value.

Links:

https://www.traverssmith.com/knowledge/knowledge-container/eu-retail-investment-directive-and-regulation/

https://url.uk.m.mimecastprotect.com/s/LnL0CQY4irXQXQFGHLIGkFHp?domain=sites-traverssmith.vuturevx.com

https://www.ukprivatecapital.co.uk/static/dd01a037-6196-4184-87b43369579f1f87/260119-UK-Private-Capital-reponse-to-CP2536-Client-Cat-and-CoI-FINAL.pdf

Current SFDR 2.0 proposals risk sidelining private funds—imposing impractical rules, stifling innovation, and missing the unique strengths of private capital. Is the EU about to bake greenhushing into law?

What’s at stake for private funds?

1. Proposals that overlook private markets: The draft framework applies retail-focused logic to all, missing how private markets operate. Ill-fitting rules could disrupt strategies and burden sponsors with unintended consequences.
2. Limits on communication with professional investors: Preventing tailored ESG disclosure does more harm than good. Professional LPs want detail, transparency, and meaningful engagement on ESG strategy—yet current rules encourage silence instead.
3. A missed opportunity for genuine engagement: Private equity influences sustainability through stewardship and direct ownership. Engagement should be central—not sidelined—to all fund categories.
4. Operational impracticalities: Rules on exclusions and portfolio alignment don’t match the realities of investing in illiquid assets. Holding managers liable for market events out of their control is unworkable. Similarly, one-year compliance for funds-of-funds is unrealistic.

What Needs to Change?

1. Permit open ESG dialogue with professional investors—exempting such communications from the tightest restrictions.
2. Recognise engagement as a core component of private fund ESG.
3. Give managers practical leeway on exclusions and portfolio reporting, including time to adjust in fund-of-funds.
4. Rethink fund labels. “ESG Basics” risks confusion and is, quite simply, not fit for purpose.

Practical Takeaways:

1. Now is the moment for asset managers to shape the rules: engage with policymakers, highlight the operational realities of the industry, and push for changes that reflect how private markets actually deliver sustainable impact.
2. Start preparing for late 2027, but focus on influencing the detail today.

How will you use your stakeholder voice as SFDR 2.0 moves forward?

Links:

1. https://www.traverssmith.com/knowledge/knowledge-container/travers-smiths-alternative-insights-the-commissions-sfdr-proposal-fails-to-deliver-clarity/
2. https://www.traverssmith.com/knowledge/knowledge-container/finalised-sfdr-20-proposals/

Links:

PEI Group data

partner for growth

Insights '26

the Corporate Sustainability Due Diligence Directive

the Corporate Sustainability Due Diligence Directive

securitisation regime

harmonise trade reporting

AIFMD II

UK AIFMD

client categorisation rules

national security deal notification

merger controls

start, scale, and stay in the UK

controversial proposal

401(k) investment into alternative assets

EU AI Act

Insights ’26

Links:

1. our detailed briefing
2. 2021 impact assessment

Links:

https://www.traverssmith.com/knowledge/knowledge-container/finalised-sfdr-20-proposals/

https://www.traverssmith.com/knowledge/knowledge-container/possible-changes-to-the-eu-sfdr-the-european-commission-seeks-views/

https://www.traverssmith.com/knowledge/knowledge-container/travers-smiths-sustainability-insights-what-will-sfdr-20-look-like/

Links:

https://www.traverssmith.com/knowledge/knowledge-container/travers-smiths-alternative-insights-the-impact-of-uk-tax-policy/

https://www.traverssmith.com/knowledge/knowledge-container/autumn-budget-2025/

https://www.traverssmith.com/knowledge/knowledge-container/autumn-budget-2025-private-capital/

https://www.fnlondon.com/articles/rachel-reeves-private-equity-will-be-key-to-growth-push-95c10a9a

https://assets.publishing.service.gov.uk/media/68595e56db8e139f95652dc6/industrial_strategy_policy_paper.pdf

https://www.bvca.co.uk/static/e07847be-bbcc-4b7e-a201d5d182700aca/BVCA-Response-to-Invest-2035-The-UKs-Modern-Industrial-Strategy.pdf

Links:

https://www.traverssmith.com/knowledge/knowledge-container/draft-sfdr-20-proposals/

https://www.traverssmith.com/knowledge/knowledge-container/sustainability-exchange-podcast/

https://uksif.org/uksif-pwc-report-uk-sdr-and-investment-labels-implementation-lessons-and-the-road-ahead/

Links:

https://www.fca.org.uk/publication/consultation/cp25-28.pdf

https://www.traverssmith.com/knowledge/knowledge-container/fca-measures-to-support-direct-2-fund-dealing-and-fund-tokenisation

https://www.theia.org/sites/default/files/2023-11/UK%20Fund%20Tokenisation%20-%20A%20Blueprint%20for%20Implementation.pdf

Links:

https://www.traverssmith.com/knowledge/knowledge-container/travers-smiths-alternative-insights-private-markets-and-policy-goals/

https://www.traverssmith.com/knowledge/knowledge-container/sustainability-and-security-investing-in-defence

https://defence-industry-space.ec.europa.eu/eu-defence-industry/defence-readiness-omnibus_en

https://data.consilium.europa.eu/doc/document/ST-12811-2025-INIT/en/pdf

https://www.rusi.org/explore-our-research/publications/insights-papers/are-esg-standards-scapegoat-stalling-defence-growth

https://www.traverssmith.com/knowledge/knowledge-container/travers-smiths-sustainability-insights-investing-in-europes-defence/

https://docs.google.com/document/d/1WpGBd6s2-MO5YQw4nVDtiH0av5TjSCMfOoIDrupHLlY/edit?tab=t.0

https://www.europeandefense.org/

https://www.ohchr.org/sites/default/files/2022-08/BHR-Arms-sector-info-note.pdf

https://www.americanbar.org/groups/human_rights/reports/defense-industry-human-rights-due-diligence-guidance/

Links:

https://www.msn.com/en-gb/money/video/80-of-draghi-investment-ask-will-come-from-private-capital-says-kkr/vi-AA1NlSif

https://www.cityam.com/rishi-sunak-assures-city-that-bonfire-of-financial-services-regulations-post-brexit-is-around-the-corner/

https://www.british-business-bank.co.uk/news-and-events/news/british-business-bank-response-autumn-budget-2024

https://www.british-business-bank.co.uk/finance-options/british-growth-partnership

https://www.bvca.co.uk/policy/nova.html

https://www.lse.ac.uk/events/open

https://www.fmg.ac.uk/isf/blended-finance-lab

https://www.bankofengland.co.uk/-/media/boe/files/speech/2015/building-real-markets-for-the-good-of-the-people.pdf

Links:

https://www.traverssmith.com/knowledge/knowledge-container/travers-smiths-alternative-insights-the-impact-of-uk-tax-policy/

https://www.traverssmith.com/knowledge/knowledge-container/new-uk-carried-interest-tax-regime-draft-rules-published/

https://www.traverssmith.com/knowledge/knowledge-container/new-uk-carried-interest-tax-regime-draft-rules-published/

Links:

https://assets.publishing.service.gov.uk/media/6735f4670b168c11ea82311d/Financial_Services_Growth___Competitveness_Strategy_-_Call_for_Evidence_.pdf

https://www.reuters.com/world/uk/uk-scrap-non-dom-tax-status-foreign-earnings-2024-03-06/

https://www.traverssmith.com/knowledge/knowledge-container/autumn-budget-2024-non-dom-regime/#thechanges2

https://on.ft.com/3Ij9PrT

https://www.traverssmith.com/knowledge/knowledge-container/rule-changes-for-european-private-fund-managers/

https://obr.uk/docs/dlm_uploads/OBR_Economic_and_fiscal_outlook_Oct_2024.pdf

https://www.traverssmith.com/knowledge/knowledge-container/government-provides-welcome-update-to-carried-interest-reform-proposals/

https://www.ft.com/content/ba781c26-f3f0-4657-bad7-d47337353790

https://on.ft.com/4nIgID5

Links:

https://www.linkedin.com/posts/travers-smith_assetmanagement-privatecapital-markets-ugcPost-7341038259122126849-K5r1?utm_medium=ios_app&rcm=ACoAAANSBP8B6s50YH7QZ6bxZ_O1alhPfCdpZEM&utm_source=social_share_send&utm_campaign=copy_link

https://www.traverssmith.com/knowledge/knowledge-container/pisces-key-questions-answered

https://www.gov.uk/government/news/government-goes-further-and-faster-to-boost-capital-markets-by-delivering-pisces

https://on.ft.com/3FyWeM2

Listen now to explore:

• How Article 8, 9, and 6 classifications truly differ, and why it matters in today’s fundraising climate
• Shifts in LP preferences, regulatory requirements, "sustainability tourists" and the evolution towards long-term value creation
• Navigating related obstacles and choosing the appropriate sustainability commitments for your investor base

Links:

https://finance.ec.europa.eu/sustainable-finance/disclosures/sustainability-related-disclosure-financial-services-sector_en#:~:text=attracting%20private%20funding%20to%20help%20Europe%20make%20the%20shift%20to%20a%20net%2Dzero%20economy.

https://www.traverssmith.com/knowledge/knowledge-container/possible-changes-to-the-eu-sfdr-the-european-commission-seeks-views/

https://finance.ec.europa.eu/document/download/0f2cfde1-12b0-4860-b548-0393ac5b592b_en?filename=2023-sfdr-implementation-summary-of-responses_en.pdf

https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/14666-Revision-of-EU-rules-on-sustainable-finance-disclosure_en

https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/14666-Revision-of-EU-rules-on-sustainable-finance-disclosure/F3562074_en

https://uksif.org/uksif-response-eu-commission-sfdr-call-for-evidence/

https://finance.ec.europa.eu/publications/categorisation-products-under-sfdr-proposal-platform-sustainable-finance_en

https://www.traverssmith.com/knowledge/knowledge-container/simplification-or-deregulation-the-eus-sustainability-omnibus-explained/

Links:

The Regulation of Hedge Funds and Private Equity: A Case Study in the Development of the EU’s Regulatory Response to the Financial Crisis by Eilis Ferran :: SSRN

Financial services – review of EU rules on alternative investment fund managers

Report on the operation of the alternative investment fund managers directive (AIFMD) – Directive 2011/61/EU

Kickstart economic growth – The Labour Party

e6cd4328-673c-4e7a-8683-f63ffb2cf648_en

Regulations for Alternative Investment Fund Managers (Accessible) - GOV.UK

Call for Input: Future regulation of alternative fund managers

Targeted consultation on integration of EU capital markets 2025 - European Commission

Commission unveils savings and investments union strategy to enhance financial opportunities for EU citizens and businesses - European Commission

The Draghi report on EU competitiveness

Links:

https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/14666-Revision-of-EU-rules-on-sustainable-finance-disclosure_en

https://www.gov.uk/government/publications/climate-related-financial-disclosures-for-companies-and-limited-liability-partnerships-llps

https://www.traverssmith.com/knowledge/knowledge-container/sustainability-disclosure-requirements-sdr-and-investment-labels-the-new-rules/#A2:~:text=section%203%20below.-,Entity%2Dlevel%20disclosures,-Requirements%20on%20UK

https://assets.bbhub.io/company/sites/60/2021/10/FINAL-2017-TCFD-Report.pdf

https://www.traverssmith.com/knowledge/knowledge-container/the-clock-stops-but-the-bus-rumbles-on-csrd-omnibus-clears-its-first-hurdle/

https://www.ifrs.org/issued-standards/ifrs-sustainability-standards-navigator/

Tune in to explore:

1. A nuanced discussion of how the term ESG is perceived across different markets, especially US investors with varied stances in different states
2. Practical advice on communicating ESG commitments consistently and factually, avoiding political pitfalls while emphasising value creation
3. How international regulatory standards influence global fund marketing strategies

Links:

FR10/23 Thematic Analysis: Emerging Risks in Private Finance

Private market valuation practices | FCA

23-013_6a38dcc8-4aff-4acc-8f28-d024728613d6.pdf

How Fair are the Valuations of Private Equity Funds? by Tim Jenkinson, Miguel Sousa, Rüdiger Stucke :: SSRN

Portfolio letter: Asset Management & Alternatives - Supervisory Strategy

Links:

Rethinking Defense: The Role of Private Capital | Bain & Company

Preqin

Woke guns? Banks want weapons badged as a social good – POLITICO

Our position on sustainability regulations and UK defence | FCA

ESMA Guidelines on Fund Names | Travers Smith

EU foreign subsidies regulation: another notification regime for dealmakers to become law | Travers Smith

Asset managers race to set up European defence funds

Dutch pensions to invest €100bn in risky assets boosting Europe’s defence efforts

23-315 EIF Policy on Exclusions and Restrictions.pdf

Norway urged to drop ‘crazy’ ban on investment in defence companies

guidingprinciplesbusinesshr_en.pdf

BHR-Arms-sector-info-note.pdf

From Berlin to Tokyo, the fears of a new nuclear arms race

Simon's guests, Ross Butler, Managing Director of Linear B Group, and Tosin Adeyeri, Partner in our Funds team, debate opposing answers to this topical question. Listen now to learn what ESG-linked carried interest means and how it works, plus the pros and cons of incorporating non-financial KPIs into fund economics from their frontline perspective.

The episode ends with a one-sentence answer from each expert guest to… Should your next fund include and ESG or perhaps impacts linked carried interest?

Links:

UK regulators to face twice-yearly reviews as Reeves vows to slash red tape | Rachel Reeves | The Guardian

New approach to ensure regulators and regulation support growth (HTML) - GOV.UK

New approach to ensure regulators and regulation support growth (HTML) - GOV.UK

Simplification or Deregulation? The EU's Sustainability Omnibus Explained | Travers Smith

How to fix Europe’s securitisation market 

US and Asia securitisation markets contribute far more to financing their economies than Europe - “Now is the time to address the gap | AFME

Investors call for shake-up of Europe’s ‘failed’ securitisation market

Reviving the UK securitisation market

Apollo Sees €1 Trillion Opportunity If Europe Overhauls ABS

Securitisation Data Report Q4 2023 & 2023 Full Year | AFME

The Opportunity Of Asset-Based Finance Draws In Private Credit | S&P Global Ratings

97e481fd-2dc3-412d-be4c-f152a8232961_en

Securitisation | FCA

Targeted consultation on the functioning of the EU securitisation framework 2024 - European Commission

ACC and AIMA respond to European Commission’s consultation on securitisation

AFME responds to the European Commission’s targeted consultation on the functioning of the EU Securitisation Framework | AFME

Links:

• Anu Bradford | Columbia Law School
• Fact Sheet: President Donald J. Trump Protects Civil Rights and Merit-Based Opportunity by Ending Illegal DEI – The White House
• Federal Register :: Pausing Foreign Corrupt Practices Act Enforcement To Further American Economic and National Security
• SEC.gov | Acting Chairman Statement on Climate-Related Disclosure Rules
• Final rule: The Enhancement and Standardization of Climate-Related Disclosures for Investors
• US judge temporarily blocks Trump’s anti-DEI purge | US news | The Guardian
• COMPS-9569.pdf
• Failure to prevent fraud guidance published – what do businesses need to do now? | Travers Smith
• Simplification or Deregulation? The EU's Sustainability Omnibus Explained | Travers Smith
• Ensuring Accountability for All Agencies – The White House
• Defending American Companies and Innovators From Overseas Extortion and Unfair Fines and Penalties – The White House
• Withdrawing The United States From The World Health Organization – The White House

Links:

Our 2024 budget briefing - https://www.traverssmith.com/knowledge/knowledge-container/autumn-budget-2024/

BVCA The tax treatment of carried interest – Consultation on qualifying conditions - https://www.bvca.co.uk/static/2e27e13b-ef87-440e-b75bb6717c8e228a/BVCA-response-to-carried-interest-consultation-31-Jan.pdf

Our briefing: Salaried members update: HMRC to reverse controversial guidance changes on increases in capital contributions - https://www.traverssmith.com/knowledge/knowledge-container/salaried-members-update-hmrc-to-reverse-controversial-guidance-changes-on-increases-in-capital-contributions/

Simon meets with James Alexander, Chief Executive of The UK Sustainable Investment and Finance Association (UKSIF) and Sarah-Jane Denton, Director of our Operational Risk & Environment team to evaluate the need, benefits, and practicality of a implementing UK-specific green taxonomy versus adopting the current EU framework.

The episode ends with a one-sentence answer from each expert guest to… does the UK need a green taxonomy?

The Sustainability Exchange was first published in our Talking. Sustainability. podcast. Follow for latest episodes in your favourite podcast player: https://feeds.captivate.fm/travers-smith-talking-sustainability-esg/

Links:

https://www.epp.eu/files/uploads/2025/01/EPP-Retreat-Growth-and-Jobs-statement.pdf

https://www.humanrights.dk/files/media/document/Letter%20of%20European%20NHRIs%20on%20the%20omnibus%20proposal.pdf

https://www.unpri.org/download?ac=22691

Links:

Insights '25 - What to expect in 2025

Investors - Alternative Insights 2025

People and DE&I - Alternative Insights 2025

Links:

https://www.traverssmith.com/knowledge/knowledge-container/travers-smiths-sustainability-insights-eu-sustainability-regulation-in-2025/

https://www.responsible-investor.com/esg-round-up-germanys-scholz-calls-for-two-year-delay-to-csrd/

https://www.traverssmith.com/knowledge/knowledge-container/icymi-a-recap-of-developments-in-eu-sustainability-reporting-in-2024/

https://www.traverssmith.com/knowledge/knowledge-container/travers-smiths-sustainability-insights-the-role-of-government-in-transition-finance/

https://www.traverssmith.com/knowledge/knowledge-container/size-matters-guidance-on-climate-related-disclosures-for-large-companies-and-llps/

https://www.gov.uk/guidance/energy-savings-opportunity-scheme-esos

https://www.traverssmith.com/knowledge/knowledge-container/from-energy-savings-opportunity-to-energy-savings-requirements/

https://www.frc.org.uk/news-and-events/news/2024/12/uk-sustainability-tac-issues-final-recommendations/

https://www.traverssmith.com/knowledge/knowledge-container/cs3d-whats-new-and-whats-next/

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5083571

https://www.theglobalcity.uk/PositiveWebsite/media/Research-reports/Scaling-Transition-Finance-Report.pdf

https://www.traverssmith.com/knowledge/knowledge-container/uk-modern-slavery-act-2015-to-reform-or-not-to-reform-that-remains-the-question-following-latest-position-from-government/

https://www.gov.uk/government/publications/modern-slavery-government-response-to-house-of-lords-committee-report

https://committees.parliament.uk/committee/700/modern-slavery-act-2015-committee/news/203272/uks-response-to-modern-slavery-has-not-kept-up-with-the-advances-of-other-nations/

https://www.traverssmith.com/knowledge/knowledge-container/sustainability-disclosure-requirements-sdr-and-investment-labels-the-new-rules/

https://www.traverssmith.com/knowledge/knowledge-container/sdr-finalised-guidance-on-the-anti-greenwashing-rule/

https://www.traverssmith.com/knowledge/knowledge-container/travers-smiths-sustainability-insights-labels-for-uk-funds-but-limited-impact-for-private-capital/

https://www.traverssmith.com/knowledge/knowledge-container/sdr-and-investment-labels-extension-of-the-regime-to-uk-portfolio-managers/

https://www.traverssmith.com/knowledge/knowledge-container/sustainability-disclosure-requirements-sdr-and-investment-labels-the-new-rules/#:~:text=wealth%20management%20services.-,Overseas%20funds%C2%A0,-The%20FCA%20says

https://www.fca.org.uk/news/statements/fca-welcomes-move-bring-esg-ratings-providers-regulation

Links:

https://www.consilium.europa.eu/en/press/press-releases/2024/11/08/the-budapest-declaration/

https://www.traverssmith.com/knowledge/knowledge-container/travers-smiths-sustainability-insights-the-impact-of-the-draghi-report-on-esg-regulation/

https://www.businesseurope.eu/sites/buseur/files/media/position_papers/legal/2024-11-05_joint_trade_association_statement_towards_eu_due_diligence_that_works_for_all_0.pdf

https://www.consilium.europa.eu/en/press/press-releases/2024/11/08/the-budapest-declaration/#:~:text=We%20must%20adopt%20an%20enabling%20mindset%20based%20on%20trust%2C%20allowing%20business%20to%20flourish%20without%20excessive%20regulation.

https://www.peievents.com/en/event/responsible-investment-forum-europe/

https://www.linkedin.com/posts/tim-lewis-a517261a_last-night-we-gathered-members-of-our-asset-activity-7265398692105314307-376F

https://www.traverssmith.com/knowledge/knowledge-container/cs3d-whats-new-and-whats-next/

https://www.traverssmith.com/knowledge/knowledge-container/csrd-the-road-to-compliance

https://apps.fliplet.com/esgapp

https://www.traverssmith.com/knowledge/knowledge-container/possible-changes-to-the-eu-sfdr-the-european-commission-seeks-views/

https://www.traverssmith.com/knowledge/knowledge-container/esas-propose-changes-to-sfdr-regulatory-technical-standards/

https://www.traverssmith.com/knowledge/knowledge-container/esma-guidelines-on-fund-names/

https://www.consilium.europa.eu/en/press/press-releases/2024/11/19/environmental-social-and-governance-esg-ratings-council-greenlights-new-regulation/

https://www.fca.org.uk/news/statements/fca-welcomes-move-bring-esg-ratings-providers-regulation

https://www.newprivatemarkets.com/pe-firms-at-risk-of-esg-litigation-says-travers-smith/

Links:

https://www.traverssmith.com/knowledge/knowledge-container/autumn-budget-2024/

https://www.gov.uk/government/speeches/mansion-house-2024-speech

https://www.gov.uk/government/news/chancellor-fires-up-financial-services-sector-to-drive-growth#:~:text=BVCA%20Chief%20Executive%20Michael%20Moore%20said%3A%C2%A0

https://assets.publishing.service.gov.uk/media/6735d9ebb613efc3f18230e9/pension_fund_investment_and_the_uk_economy.pdf

https://www.gov.uk/government/publications/pensions-investment-review-interim-report

https://www.ft.com/content/362ca4cd-a892-4525-bddf-82abe5f339b4#msdynmkt_trackingcontext=910b9634-aa02-4b3a-a831-bcb7e4b55c60

https://assets.publishing.service.gov.uk/media/67372cf9c0b2bbee1a127202/pensions_investment_review_unlocking-the_uk_pensions_market_for_growth.pdf

https://www.gov.uk/government/calls-for-evidence/financial-services-growth-and-competitiveness-strategy

https://on.ft.com/3V9Tpp8

Links:

https://unfccc.int/cop29

https://www.bbc.co.uk/news/articles/cpqd1rzw9r4o

https://www.bbc.co.uk/news/articles/cx2lknel1xpo

https://www.traverssmith.com/knowledge/knowledge-container/what-to-expect-at-cop29/

https://unfccc.int/process-and-meetings/the-paris-agreement

https://unctad.org/publication/new-collective-quantified-goal-climate-finance

https://www.bbc.co.uk/news/science-environment-54797743

https://www.ft.com/content/24b994ec-9d69-47df-8c23-efc5762877e9

https://unfccc.int/resource/docs/convkp/conveng.pdf

https://www.traverssmith.com/knowledge/knowledge-container/travers-smiths-sustainability-insights-the-role-of-government-in-transition-finance/

https://www.iigcc.org/hubfs/IIGCC%20publishes%20open%20letter%20in%20support%20of%20an%20ambitious%20New%20Collective%20Quantified%20Goal%20on%20climate%20finance.pdf

https://www.newprivatemarkets.com/tpg-and-brookfield-hail-climate-fund-momentum/

https://www.bbc.co.uk/news/articles/cx2ny8zndpxo

https://www.bbc.co.uk/news/articles/c4gve4d8jljo

Links:

https://www.gov.uk/government/news/record-breaking-international-investment-summit-secures-63-billion-and-nearly-38000-jobs-for-the-uk

https://www.cityam.com/bosses-at-worlds-biggest-banks-britain-is-ready-for-investment/

https://www.gov.uk/government/speeches/pm-international-investment-summit-speech-14-october-2024

https://www.gov.uk/government/news/game-changing-tech-to-reach-the-public-faster-as-dedicated-new-unit-launched-to-curb-red-tape

https://www.cityam.com/rachel-reeves-promises-to-revolutionise-uk-capital-markets-and-boost-london-listings/

https://www.gov.uk/government/news/dan-corry-appointed-to-lead-defra-regulation-review

https://assets.publishing.service.gov.uk/media/670cde8692bb81fcdbe7b745/industrial-strategy-green-paper-final.pdf

https://www.ukib.org.uk/

https://www.british-business-bank.co.uk/finance-providers-equity-finance/british-growth-partnership

https://www.linkedin.com/posts/bvca_a-significant-step-forward-for-investment-activity-7251635037433991168-ztWw/

https://www.theglobalcity.uk/PositiveWebsite/media/Research-reports/Scaling-Transition-Finance-Report.pdf

https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:32023H1425

https://www.ft.com/content/c0ca95ce-ffcf-4c10-b789-174e359e16ef

https://player.captivate.fm/episode/457a3e0b-8938-43d1-8590-64e33625b7c0/

https://url.uk.m.mimecastprotect.com/s/VBJCC8p4c9q036txt0FyxU-_?domain=sites-traverssmith.vuturevx.com

In the fifth episode of our Sustainability Insights … in conversation series, where we discuss the role of responsible investment in improving risk-adjusted returns, in aligning values, and in solving real world problems.

Does Sustainable Investing Work?

Links:

https://academic.oup.com/book/36491

https://digital-strategy.ec.europa.eu/en/policies/european-approach-artificial-intelligence

https://www.theguardian.com/books/2023/sep/02/i-hope-im-wrong-the-co-founder-of-deepmind-on-how-ai-threatens-to-reshape-life-as-we-know-it

https://oecd.ai/en/ai-principles

https://www.esma.europa.eu/sites/default/files/2024-05/ESMA35-335435667-5924__Public_Statement_on_AI_and_investment_services.pdf

https://www.traverssmith.com/knowledge/knowledge-container/travers-smiths-alternative-insights-financial-regulation-and-ai/

https://www.traverssmith.com/knowledge/knowledge-container/travers-smiths-alternative-insights-financial-regulation-and-ai/

https://www.gov.uk/government/consultations/ai-regulation-a-pro-innovation-approach-policy-proposals/outcome/a-pro-innovation-approach-to-ai-regulation-government-response

http://opiniojuris.org/2020/11/25/the-time-has-come-for-international-regulation-on-artificial-intelligence-an-interview-with-andrew-murray/#:~:text=I%20would%20much%20prefer%2C%20if%20possible%2C%20if%20this%20was%20a%20truly%20international%20(UN%2Dled%2C%20for%20example)%20exercise%20wherein%20countries%20like%20China%20are%20on%20board%20and%20not%20feeling%20coerced%20into%20adopting%20something

Links:

https://commission.europa.eu/document/download/97e481fd-2dc3-412d-be4c-f152a8232961_en

https://www.ft.com/content/298008a0-b75d-4062-9cb1-86b12ac30fbd

https://commission.europa.eu/document/download/ec1409c1-d4b4-4882-8bdd-3519f86bbb92_en

https://ec.europa.eu/commission/presscorner/detail/en/IP_00_96

https://www.epc.eu/content/PDF/2024/20230277_hidden_champions_missed_opportunities_en.pdf

https://www.traverssmith.com/knowledge/knowledge-container/new-mandatory-tcfd-reporting-for-more-uk-companies/

https://commission.europa.eu/system/files/2023-03/Communication_Long-term-competitiveness.pdf

https://doi.org/10.1093/jfr/fjac001

https://link.springer.com/article/10.1007/s11142-021-09609-5

https://www.bvca.co.uk/Portals/0/BVCA%20Response%20to%20FRC%20UK%20SD%20TAC%20CfE.pdf

https://commission.europa.eu/document/download/e6cd4328-673c-4e7a-8683-f63ffb2cf648_en?filename=Political%20Guidelines%202024-2029_EN.pdf

Links:

McKinsey's 2024 Global Markets Review

ILPA guidance on continuation funds

ILPA review of its highly impactful reporting template

ILPA guidance on NAV-based facilities

Financial Stability Report

BVCA pointed out

ILPA Guidance

In the fourth episode of our Sustainability Insights … in conversation series, Simon Witney speaks to Diandra Soobiah, Director of Responsible Investment at Nest, the National Employment Savings Trust. Their discussion explores Nest's significant commitments to the private markets and, with 15% of NEST's £42 billion AUM allocated to private markets, Diandra explains what more she wants to see from the sector.

To see the agenda for our Summit, click here. 

Links:

https://www.traverssmith.com/knowledge/knowledge-container/travers-smiths-alternative-insights-back-to-work/

https://www.linkedin.com/posts/travers-smith_assetmanagement-alternativeinsights-privatecapital-activity-7217464206562865152-BOcr

https://www.linkedin.com/posts/travers-smith_assetmanagement-investigations-markets-activity-7219621018435227648-h7dE

https://www.linkedin.com/posts/travers-smith_markets-assetmanagement-pensions-activity-7221107755879731200-eAlh

https://www.bvca.co.uk/Policy/Investment-Compact

https://www.linkedin.com/posts/travers-smith_assetmanagement-tax-markets-activity-7221835553900531714-vyWu/

https://www.linkedin.com/posts/travers-smith_esg-sustainability-markets-activity-7218950444658626560-d1kP/

Links:

https://www.bain.com/insights/topics/global-private-equity-report/

https://www.collercapital.com/coller-capitals-40th-global-private-capital-barometer-summer-2024/

We have released the third episode in our podcast series Sustainability Insights … in conversation. In conversation with Simon Witney, Ellen De Kreij, lead advisor to Apax’s Operational Excellence Practice on Impact and Sustainability, explains how Apax selects impact investments, how they work with management to promote impact, and how they report on impact to their investors.

Listen to the conversation here, and please subscribe to receive future editions in this podcast series direct to your inbox.

Links:

https://www.cer.eu/insights/what-will-eu-election-results-mean-europe

https://uksif.org/wp-content/uploads/2023/08/Letter-to-PM-on-NZ-commitment-Aug23-UPDATED.pdf

https://www.gov.uk/government/news/uk-becomes-first-major-economy-to-pass-net-zero-emissions-law

https://www.gov.uk/government/news/plans-unveiled-to-decarbonise-uk-power-system-by-2035

https://www.gov.uk/government/news/uk-enshrines-new-target-in-law-to-slash-emissions-by-78-by-2035

https://www.gov.uk/government/publications/net-zero-strategy

https://www.traverssmith.com/knowledge/knowledge-container/biodiversity-net-gain

https://www.bbc.co.uk/news/articles/cw44vj3e1wyo

https://www.traverssmith.com/knowledge/knowledge-container/sustainability-disclosure-requirements-sdr-and-investment-labels-the-new-rules/

https://www.traverssmith.com/knowledge/knowledge-container/travers-smiths-sustainability-insights-the-european-commissions-review-of-sfdr/

https://www.greenfinanceinstitute.com/wp-content/uploads/2023/10/GTAG-Chair-Final-Statement.pdf

https://committees.parliament.uk/publications/43465/documents/216119/default/

https://www.traverssmith.com/knowledge/knowledge-container/the-carbon-border-adjustment-mechanism-recap-and-updates/

https://www.gov.uk/gov

https://betterbusinessact.org/ernment/consultations/addressing-carbon-leakage-risk-to-support-decarbonisation

https://www.bbc.co.uk/news/uk-politics-68244772

https://www.bvca.co.uk/Portals/0/Documents/Research/2024%20Reports/BVCA-Manifesto-For-Growth.pdf

https://labour.org.uk/wp-content/uploads/2024/01/Financing-Growth.pdf

Apax were quite the early movers in the impact space, having started to focus on their portfolio companies' ESG footprints in 2012, and over the years have exemplified the power of the private markets when thinking about impact and sustainability.  

Links:

https://www.traverssmith.com/knowledge/knowledge-container/sec-finalises-private-fund-adviser-rules/

https://www.traverssmith.com/knowledge/knowledge-container/aifmd-ii-the-next-phase-of-eu-alternative-investment-fund-regulation/

https://www.ft.com/content/a3138e87-1e8b-494b-80c3-7361c554b379

https://www.bvca.co.uk/Portals/0/Documents/Policy/Submissions/220425%20BVCA%20response%20to%20SEC%20private%20fund%20adviser%20proposals.pdf

https://ilpa.org/quarterly-reporting-standards/

https://ilpa.org/wp-content/uploads/2024/06/ILPA-Launches-Comment-Period-for-Quarterly-Reporting-Standards.pdf

Links:

https://www.traverssmith.com/knowledge/knowledge-container/sdr-finalised-guidance-on-the-anti-greenwashing-rule

https://www.traverssmith.com/knowledge/knowledge-container/sustainability-disclosure-requirements-sdr-and-investment-labels-the-new-rules/

https://www.traverssmith.com/knowledge/knowledge-container/travers-smiths-sustainability-insights-the-uks-anti-greenwashing-rule/

https://www.traverssmith.com/knowledge/knowledge-container/esma-guidelines-on-fund-names/

https://www.esma.europa.eu/sites/default/files/2024-05/ESMA34-472-440_Final_Report_Guidelines_on_funds_names.pdf

https://www.traverssmith.com/knowledge/knowledge-container/esma-guidelines-on-fund-names/

https://www.traverssmith.com/knowledge/knowledge-container/sustainability-disclosure-requirements-sdr-and-investment-labels-the-new-rules/#:~:text=Naming%20and%20marketing%20rules

https://eur-lex.europa.eu/eli/reg_del/2020/1818/oj#:~:text=in%20Article%205.-,Article%2012,-Exclusions%20for%20EU

FCA's AI update: AI Update (fca.org.uk)

Our note on the FCA's update The FCA and Bank of England's "strategic approach" to AI – what it means for regulated firms | Travers Smith

Links:

Sustainability Disclosure Requirements - Our detailed analysis of the guidance is here

FCA has also issued detailed guidance

Feedback from the BVCA

FCA CP24/8: Extending the SDR regime to Portfolio Management

Links:

• TUC - "The biggest upgrade of workers’ rights in a generation"
• IER - CBI lobbying to ‘soften’ Labour’s workers’ rights pledges, FT reports.
• FT - Keir Starmer seeks to reassure business over Labour’s worker rights pledges
• IER - Row rumbles on as business leaders line up against a 'full fat' New Deal for workers - IER
• European Commissions - Social Europe: More transparent and predictable working conditions for workers in EU
• European Council - Platform workers: Council confirms agreement on new rules to improve their working conditions
• FCA proposals for asset managers
• US FTC proposed ban on employers imposing non-competes on employees
• UK government's Department for Business & Trade 'Non-Compete Clauses'
• Raconteur - is this the death of the non-compete clause?
• The Hill - 'Banning non-compete agreements hurts US companies and workers'
• CMA research report on competition and market power in UK labour market
• SHRM - ' Will the FTC Finalize a Compete Ban on Noncompetes?'

Links:

EU's new Foreign Subsidies Regulation

Travers Smith's Alternative Insights: The impact of the EU's new rules on foreign subsidies

The European Commission's recent policy brief

Links:

Aligning the EU Due Diligence Directive with the International Standards: Key Issues in the Negotiations

FT article - France seeks weaker EU due diligence rules for banks

Forecast for 2024 European Parliament elections

European lawmakers reached an in-principle agreement on the Commission's 2022 proposal to ban products from the EU market that are made with forced labour

US Uyghur Forced Labor Prevention Act

Call for evidence issued by an influential Parliamentary Committee

Our recent note on similar European rules 

OECD Due Diligence Guidance for Responsible Business Conduct

Business and Human Rights Resource Centre - UK: Update - 50 businesses sign statement calling for human rights due diligence legislation

Our briefing - "Value chain" negligence claims: the door has been opened

Our ESG risk map

Links:

• An analysis by Blackrock
•  ILPA's guidelines issued in 2017
• In 2022, Citi was reported to have scaled back its lending by over two-thirds
• Rating agencies (GLI Fund Finance 2024 - Rated subscription lines: An emerging solution tot he liquidity crunch | Travers Smith)

We launched a new podcast series in February: Sustainability Insights … in conversation. In the first edition, Simon Witney discussed topical issues – including the global ESG landscape and responsible AI – with Cornelia Gomez, Global Head of ESG at General Atlantic. 

Listen to the podcast here, and sign up here if you want the second edition to land in your inbox.

We are launching a new podcast series in February: Sustainability Insights … in conversation. In the first edition, Simon Witney will discuss topical issues, including the global ESG landscape and responsible AI, with Cornelia Gomez, Global Head of ESG at General Atlantic.  Sign up on our website (www.traverssmith.com) and it will land in your inbox next week.

Links:

• The EU's Corporate Sustainability Reporting Directive
• PERG – the Private Equity Reporting Group
• The PwC analysis of good practice
• The Walker Guidelines commissioned by the BVCA and written by Sir David Walker in 2007
• TCFD further reforms announced and then ditched, following a call for evidence to gather ideas for simplifying the rules
• This year's PERG report
• The UK's Financial Reporting Council's review of reporting by the UK's largest private companies
•  FRC's Guidance on the Strategic Report and Thematic review of climate-related metrics and targets
• The Wates Corporate Governance Principles for Large Private Companies, the UK Corporate Governance Code itself (amended this year, and with updated guidance) and the CGI model terms of reference for an ESG Committee
• "Section 172" statement 
• ESG Footprints in Private Equity Portfolios: Unpacking Management Instruments and Financial Performance

In this week's issue of Alternative Insights, we look at how the UK government and regulators are approaching post-Brexit reforms.

Earlier this month, the FCA, the UK regulator, announced that its consultation on a sustainability disclosure and labelling regime for asset managers and regulated asset owners would be delayed until the autumn. While it is clearly important to take the time needed to get these complex rules right, many firms will be disappointed by the delay. They have been waiting to see what the UK's equivalent of the EU's Sustainable Finance Disclosure Regulation (SFDR) will look like. 

The UK has made the right decision, confirmed in a discussion paper issued last year, to separate its sustainability disclosure rules from its proposed fund labels. Unlike the SFDR, the UK intends to lay down minimum standards for "green" investment products from the outset, so that investors can rely on the labels when making investment decisions. 

Some fund managers have welcomed the prospect of a specific "impact fund" label. If appropriately defined, an impact-specific label could be helpful in the fight against "impact-washing", and might give investors greater confidence that their investments will actually deliver positive outcomes. 

But coming up with an appropriate definition is not easy.  Last month we hosted a webinar to debate how regulators should seek to define impact – and then, importantly, how to police it.

To some investors, the EU SFDR's "Article 9" category looks like a proxy for an impact fund, but – as Finance Watch and other NGOs have pointed out – there are no objectively set minimum standards under Article 9.  

It is true that the regulatory guidance strongly suggests that all investments made by an Article 9 product must be categorised as "sustainable" by the fund manager (subject to very limited exceptions), but considerable doubt remains about the definition of a "sustainable investment" – and different firms are taking very different approaches.  That means many true impact funds may conclude that they fail to qualify under Article 9, especially in light of a renewed focus on greenwashing risks. 

One issue is that the SFDR does not (yet) make clear whether transitional assets – for example, those that are in hard-to-abate sectors such as cement manufacturing – can qualify for inclusion in an Article 9 portfolio, nor whether it makes a difference if the activities concerned are, like cement production, eligible for alignment with the EU Green Taxonomy. For socially sustainable investments, firms don't even have a taxonomy to guide them, and are given considerable scope to determine which social outcomes qualify as "sustainable". (An EU social taxonomy is in development, but seems several years away from being finalised.)

At the same time, more recent guidance suggests that a fund should not use the word "impact" in its name unless the fund's investments "are made with the intention to generate positive, measurable social and environmental impact alongside a financial return". This is a pretty basic definition of an impact fund, derived from the GIIN's (Global Impact Investment Network's) widely used "core characteristics", but omits important nuances: for example, the requirement to mitigate negative impacts. Importantly, the EU guidance does not specify that only Article 9 funds can call themselves "impact funds"; indeed, many "Article 8" funds will rightly claim that they satisfy the GIIN requirements. 

This lack of clarity is clearly unhelpful, and the UK has an opportunity to do a better job.  

In its discussion paper last year, the FCA mooted various ways to define an impact fund, but none is without its issues. For example, they contemplate adopting requirements for "intentionality" and "additionality", which would be hard to police and, according to the FCA, would make its impact label only applicable to a "(small) sub-set" of SFDR Article 9 products.

On the other hand, and in contrast to the FCA's proposed labels for "transitioning" and "aligned" products, there does not appear to be any direct linkage between the FCA's proposed "impact" label and the forthcoming UK Green Taxonomy.

Some argue that a link between the Taxonomy (whether the UK or the EU version) and an impact label would be helpful to ensure that impact funds only make investments that are objectively determined to be "sustainable". There are, however, a number of issues with that approach. The most obvious is that there is, as yet, no European taxonomy to classify socially sustainable investments, no UK-specific taxonomy at all, and an EU environmental taxonomy that is not yet fully operational, with further developments already mooted.  

But there are more fundamental issues with any direct link to the Taxonomy in minimum standards specified by the UK regulator and, in time, the EU. Most crucially, the data required to certify an activity as taxonomy-aligned may not be available. For investments in large EU companies, who will soon be obliged to report their taxonomy-alignment, that may be a short-term issue, but for investments outside the EU – and especially in less developed markets, where impact investments are sorely needed – the problem is unlikely to disappear in the foreseeable future.

And, even if data is available to make the taxonomy assessment, there will be important questions about whether an investment that is not currently taxonomy-aligned, but which is working towards it – or is otherwise making significant and measurable improvements in its operations to minimise its negative impacts – should be capable of inclusion in an impact-labelled fund.

Some will also argue that the approach that regulators adopt with regard to retail products should differ from that which is best suited to products only aimed at sophisticated institutional investors, who might have their own (dynamic and context-specific) views about what constitutes "impact".

These are not easy questions to resolve, but the BVCA has also urged the FCA to make sure that the rules are appropriate for private, blind pool funds that invest in illiquid assets. Such funds are well-placed to use their active ownership model to deliver positive outcomes, but their features also add to the complexity: for example, it may not be possible (or in investors' interests) to sell an asset quickly if it ceases to meet pre-defined portfolio composition rules.

The FCA's thinking is likely to have moved on significantly since it published its discussion paper in November and will, no doubt, take note of a more recent industry-led initiative to create a "Just Transition" label. It is disappointing that firms will not know the FCA's current intentions until the autumn – but if the final proposals manage to balance the complex competing considerations appropriately, the wait will have been worth it.

It has been clear for some time that regulators are concerned about "greenwashing", by which they mean the risk that companies, investors and asset owners will overstate their sustainability credentials in order to attract capital. But, in the last few weeks, the regulatory pressure has significantly increased. Recent announcements from the SEC, the US regulator, and ESMA, the pan-EU supervisor, will focus the minds of all asset managers, including those running private funds.

In the US, proposed new SEC rules for ESG disclosures by investment advisers will buttress an already sharp focus on sustainability claims by the Division of Enforcement. The SEC's proposal, published on 25 May, is designed to "promote consistent, comparable, reliable – and therefore decision-useful – information for investors". It will apply to all SEC-registered advisers but also (to a more limited extent) to "exempt reporting advisers", a category that includes many European firms with US investors. The change would be to Form ADV – the annual filing that investment advisers (including private fund advisers) are required to make – and would require detail on an adviser's use of "ESG factors", which are not themselves defined, as well as disclosure of third party frameworks that it uses and relationships with "related persons" who are ESG service providers.

In some respects the SEC's proposals resemble the EU's Sustainable Finance Disclosure Regulation (SFDR): the US rules would require firms to categorise their investment products according to whether they "integrate" ESG factors alongside other (non-ESG) factors; whether they are "ESG-Focused", using one or more ESG factors as a "significant or main consideration in selecting investments or engaging with portfolio companies"; or whether they adopt an "ESG-Impact" strategy, and therefore target portfolio investments that drive specific and measurable environmental, social, or governance outcomes.

Like the SFDR, these categories determine disclosure requirements, but are not labels: they do not guarantee any particular investment strategy or minimum ESG standards. It will be important, therefore, for the SEC to ensure that investors do not come to regard the categories as if they were labels – a significant problem with the EU rules, acknowledged by the EU regulators. But, although the scope of "ESG" is not defined in the currently proposed SEC rule, the three product categories seem clearer and easier to understand than their SFDR-equivalents.

In fact, despite that similarity, the SEC's proposals for private fund advisers are much less extensive than those which apply under the SFDR. Indeed, they are also less extensive than other SEC proposals (included in the same release) for US registered investment companies and business development companies. The additional information that needs to be provided in the Form ADV should help investors to understand the sustainability features of an investment product, and help the SEC to enforce its prohibition on misleading investors, but does not extend to detailed metrics or anything close to EU Taxonomy-style reporting. The focus on "greenwashing" may be acute, but investors have largely been left to define the detail of the required reporting for themselves.

Meanwhile in Europe last week, ESMA issued a wide-ranging "Supervisory Briefing" that stressed the need for EU national regulators to look hard at compliance with the SFDR. When taken together with the European Commission's Q&A on the interpretation of the SFDR and the Taxonomy Regulation and a joint statement by the EU regulators also issued last week, the strict approach to application of the new rules is very clear – making an already tough job even harder for affected firms.

For example, the European Commission's guidance confirmed that legacy funds – those not made available to investors after the SFDR became effective – are subject to the SFDR's disclosure regulations if they promoted certain sustainability characteristics. In its briefing, ESMA argues that national regulators "could reasonably expect" an SFDR Article 9 product – that is, one that has sustainable investment as its objective – to disclose the detailed "principal adverse impact" metrics for all of its underlying investments, which goes further than the law strictly requires. ESMA goes on to give "guidance" on fund names: use of the term "sustainable" in a fund's name seems to be restricted to those making "sustainable investments" according to the EU's definition of that term. Moreover, if a firm wants to be categorised as a fund that "promotes environmental or social characteristics" – the lightest category of ESG fund in the SFDR – ESMA confirms that it must have some "binding criteria" as part of its investment strategy and/or objectives, although in our view these need only be binding in the sense that they must be done in the way described, and do not have to mean that certain investments must be excluded. (More commentary on these recent announcements is available in our client bulletin.)

These European "clarifications" and guidance are, in part, a recognition of the lack of clarity in the original rules, both those that are included in the Level 1 EU Directive and in the Level 2 implementing rules developed by the regulators and issued in final form by the Commission in April. But they are also an attempt to course correct: the regulators are concerned that the SFDR categories and self-certification process themselves give rise to a risk of greenwashing – something which they are now working hard to avoid. This ratcheting up of expectations will therefore continue.

As if to emphasise the current focus on greenwashing, prosecutors in Germany raided the offices of DWS last week to investigate allegations of greenwashing by the asset manager, and last month the SEC announced a settlement with BNY Mellon that involved a payment of $1.5 million. These related to public funds, which will of course be the prime focus for enforcement. But private fund managers should take careful note, because – despite their mostly institutional and sophisticated investor base – they are not likely to avoid the spotlight for long.

Read previous issues of Travers Smith's Alternative and Sustainability Insights. 

Just about everyone agrees that a single set of internationally accepted sustainability disclosure standards would benefit all stakeholders. But global convergence creates significant challenges. For example, policymakers who are keen to set very high standards – the EU, for example – will be tempted to goldplate any requirements that can achieve widespread approval. That's especially likely because different stakeholders have different expectations, and some jurisdictions will want to satisfy a wide range of constituencies. Moreover, achieving widespread buy-in requires extensive consultation and due process, which takes longer than many are willing to wait.

When the International Sustainability Standards Board (ISSB) was established last year, its goal was ambitious: to create a global baseline for corporate reporting, and to do it quickly. Publication in March of two consultation draft standards, one on general requirements for sustainability disclosures and the other covering climate-specific risks and opportunities, is a big step forward. When the standards are finalised – which could be as soon as the end of this year – they will encourage many companies to make a step change in sustainability reporting. 

It will be up to individual countries to decide whether to mandate the finalised standards, and for which companies. Some will do so quickly: UK policymakers, for example, have already said that they will use the ISSB's standards as the "backbone" for UK corporate sustainability reporting requirements, perhaps, in time, applying them to large private companies as well as their listed counterparts. Other standard-setters, including EFRAG in the EU – which has just launched its own consultation on sustainability reporting standards – will take careful note, even if they ultimately opt for some divergence, as the EU certainly will.

The ISSB has been acutely aware of the challenges in delivering a globally accepted framework, and explicitly recognises that its standards will not be the complete answer. That's at least in part because it adopts a "materiality" rule: disclosures are only required when they are relevant to an entity's enterprise value. The standards will require companies to provide the information required by investors. Reports will not include the external impacts of corporate activity unless they have a financial impact on the entity.

This approach is not as narrow as it might appear: it is clear from the drafts that a very wide range of matters could be "material", including (for example) corporate reputation, longer-term regulatory risks, the stability of a company's workforce, and its "relationships with local communities and natural resources". Disclosures are therefore expected in relation to (among many other things) an entity's employment practices and those of its suppliers, wastage related to the packaging of the products it sells, events that could disrupt its supply chain, and any sustainability-related risks in the company's value chain.

Nevertheless, the ISSB also recognises that there are limitations with its approach. Many jurisdictions (including the UK and the EU) will go further and extend the requirements to capture "double materiality" – which means including impacts that are not financially material to the reporting entity itself ("negative externalities"). The ISSB standards are therefore designed as a "global baseline", built with the expectation that some regulators will supplement them. Indeed, the ISSB has just signed a memorandum of understanding with the GRI, whose multi-stakeholder standards are widely respected, so that the two reporting frameworks will align with each other. The ISSB is also pushing for international collaboration through a new multi-jurisdictional working group.

These consultations are timely: the ISSB has balanced the need for speed with the due process that its sister organisation, the International Accounting Standards Board (IASB), is known for. The IFRS Foundation has adapted the ISSB's procedures so that these drafts could be published quickly – and, crucially, in time for them to be taken into account by the US and EU standard-setters, who are already consulting on their own sustainability disclosure rules. But the Board intends to re-consider them fully in response to stakeholder feedback later this year, following a 120-day consultation period that ends on 29 July.

In part, the rapid development of the first two draft standards has been possible because they draw heavily on existing work, which should also make global agreement easier. The standards are consistent with the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD) and they build on the sector-led approach of the SASB Standards. Both the general requirements and the climate-specific standards require disclosure of material information about all significant sustainability-related risks and opportunities facing the entity using the TCFD's four themes: governance, strategy, risk management, and metrics and targets.

There is no doubt that the standards are demanding and principally aimed at large companies. On climate, for instance, they require disclosure of scope 3 greenhouse gas emissions unless the entity explains that "a faithful measure" is not available, and they mandate the use of scenario analysis, unless the company "is unable to do so" (in which case it must use another method to assess its climate resilience). For firms in the financial sector, emissions that are facilitated or financed are explicitly included, building on the GHG Protocol Corporate Value Chain Standard, which includes guidance on calculating indirect emissions resulting from investments.

The ISSB's ambition is clear: that comprehensive and internationally consistent sustainability disclosures are published with a company's financial statements and are treated by users as being on an equal footing with them. The rapid progress on this first set of standards is to be applauded, and would seem to put that ambition within reach.

Towards the end of last year, many private fund managers began reviewing their approach to interest rate risks. Although private funds are often heavily exposed to movements in interest rates – most obviously in relation to leveraged portfolio investments, but also for fund-level facilities and manager-level liquidity – low and stable rates have been the norm for the past 10 years, making interest rate risk a relatively low priority. That has clearly changed: central bank announcements warning of phased increases in interest rates, along with governmental pressure to combat rising inflation, have prompted many funds to consider how to hedge against future rises.

A firm's review of its approach to interest rate risks is likely to start with an assessment of its own knowledge and skills. Fund managers – and portfolio company finance teams – clearly need to model the impact of expected future rate rises on returns and liquidity needs, but also need to understand the tools that are available to manage the risks, and the circumstances in which they can be deployed.

That is partly about making sure the firm has the right expertise (internally or externally) to identify, and then negotiate terms for, the instruments that can ensure that risks are appropriately hedged. It will also be important for the firm to analyse the regulatory framework that applies to the use of any derivatives for hedging – including restrictions and additional reporting requirements imposed by both specific derivatives rules such as EMIR, and by more general pan-European legislation, most obviously the AIFMD and MiFID (and their UK equivalents). Any provisions on hedging (or related aspects, such as fund guarantees) in the fund's Limited Partnership Agreement (LPA) will need to be navigated, and the impact of hedging at fund-level on the borrowing base under a fund-level facility fully understood.

Managers seeking interest rate protection by accessing the bank and broker-led markets will need to put in place appropriate legal agreements, so an understanding of current ISDA terms and model documents is needed. These are specialist documents, and a firm's regular fund formation or fund finance counsel may not be familiar with the detailed provisions or market practices. Therefore, managers should not underestimate the time that it can take to agree them, especially because they should be tailored to the specific fund.

Establishing or reviewing policies and procedures for interest rate risk management will require firms to address questions of responsibility and accountability among the portfolio management, legal and compliance and finance teams.

It is likely that some of these required skill sets and advisory relationships will need refreshing. Establishing or reviewing policies and procedures for interest rate risk management and the use of derivatives will flush out gaps and will require firms to address questions of responsibility and accountability among the portfolio management, legal and compliance and finance teams. Such clear procedures are vital and, indeed, investors may be expected to ask more questions about them as we enter a higher interest rate environment.

Some managers, recognising the specialist skills needed, have sought to implement systematic interest rate risk management on a centralised basis across their portfolio. This marks a change to the more traditional approach where interest rate risk management was delegated to the underlying investee companies and portfolio manager, rather than being subject to centralised modelling and oversight. While centralisation does bring some advantages, there are also challenges to address: for example, the portfolio manager and portfolio company finance director will know the underlying investment best, and where any interest rate risk lies. The firm's finance function will have vital expertise, especially as they will deal with fund-level bridge and NAV facilities, foreign exchange derivatives, accounting and LPA issues, but they will also need detailed information about each portfolio investment in order to make good decisions about the appropriate tools to deploy at that level.

There may also be a sustainability angle to a renewed focus on interest rate derivatives. While some firms have already taken advantage of the young, but rapidly developing market in ESG-linked loans, sustainability-linked derivatives are in their infancy. As with the loan market, the idea is that if a firm or a portfolio company hits some bespoke ESG targets it will benefit from a (relatively small) reduction in the margin paid to the hedge counterparty. These products are likely to become increasingly available as the market develops.

Most of the risks of not addressing rising interest rates are obvious, and managers with significant exposure to floating rate debt will be on top of them. However, optimising risk mitigation strategies can pay dividends. Knowledge of the market is clearly crucial in pricing negotiations, while early analysis of the documentary and regulatory issues can prevent last minute hitches or inadvertent breaches.

Read previous issues of Travers Smith's Alternative and Sustainability Insights.

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It is to be expected, therefore, that the European Commission will have to amend, evolve and clarify its new rules in some important respects in the coming years. ESMA, the pan-EU supervisor, recently explained how it is going to help – and its Sustainable Finance Roadmap offers alternative asset managers some clues about what is likely to change in the near future.

ESMA's roadmap, published in February and building on the Commission's own priorities, points out that it must respond to "copious legislative activity" and "strong investor demand for sustainable products". Combating greenwashing and promoting transparency is clearly regarded as a central part of ESMA's mission – and the SFDR's de facto labels are identified as part of the problem. The European Commission has already announced that it will develop minimum standards for "Article 8 products" – those that promote environmental and/or social characteristics – and ESMA plans to support the Commission's work in this regard.

The lack of minimum standards is perhaps not surprising in a disclosure regime, but baseline criteria would seem to be a prerequisite for a label. In fact, ESMA has been adamant on a number of occasions that the SFDR is not a labelling regime, and the supervisor is aware that – if it is seen as such by investors – it could result in investors being misled.

But there is also a recognition among policymakers that – whether intended or not – the SFDR's categories are being used as labels, and moving to underpin them with some minimum standards is now the inevitable response. That view is shared by a group of NGOs and consumer organisations, who issued recommendations for minimum criteria in February.

The NGOs' view is that Article 8 products should be required to avoid harm, while an Article 9 designation should be reserved for funds having positive and measurable impact. Products should, according to these recommendations, include some exclusions – so that, for example, an Article 8 product could not invest in fossil fuel or nuclear energy generation – and have a minimum level of alignment with the EU Taxonomy.

Any such minimum standards would seem to require an amendment to the SFDR itself, so it is not a quick process, but the industry will need to engage with ESMA as they develop proposed minimum standards. Even if not applied retrospectively to products marketed under the existing rules (which would be wrong in principle), investors are unlikely to stop demanding Article 8 products because the criteria have changed. Many firms will be forced to adopt whatever minimum criteria end up being applied.

Another aspect of the SFDR that has come in for some criticism is the choice of "principal adverse impact" (PAI) indicators that are specified in the implementing rules that were published this week. Firms who are currently aligning their data collection processes with those indicators should take note that ESMA is already planning to review them.

Meanwhile, a supervisory statement issued by ESMA and other supervisors in late March confirmed that asset managers must start issuing a quantitative taxonomy-alignment score for certain products, even though that data is not yet widely available. The supervisors confirmed that estimates may not be used and that additional information (other than information on how the data was obtained) should not be provided. However, the statement also confirms that firms may engage directly with investee companies to gather the data if needed. There still seems to be no obligation for an alternative asset manager to collect data from companies that are not themselves reporting taxonomy-alignment: instead, they could classify the company as 0% aligned. But EU-based investors are likely to want alternative asset managers to perform their own taxonomy assessments. Given the complexity in making a taxonomy-alignment determination, especially for non-EU assets, that will be an ongoing challenge.

Those taxonomy determinations are also not likely to get easier, even if consultancy solutions do emerge. That's because the taxonomy will grow. Not only is a social taxonomy in development, but recent announcements suggest that enhancements to the green taxonomy are also likely. The Platform on Sustainable Finance argues in its latest report for an extended environmental taxonomy, suggesting a traffic light system that allows all economic activities to be classified according to their environmental impact.

The EU's ambition to be the global leader in sustainability standards shows no sign of abating – even though the UK and the US are now playing catchup. For market participants getting to grips with the existing EU sustainability rules, some clarity is gradually emerging and, in particular, reporting templates and final SFDR reporting requirements seem to be settled for the time being (unless the co-legislators object to the Commission's proposed version). But new challenges are undoubtedly also on their way as European rule-makers build on what they have accomplished so far.

Last month, the UK government made some important announcements about its post-Brexit plans to re-vamp the funds regime.  Many alternative asset managers will be disappointed that a number of industry suggestions have not (yet) been taken up.

For the last two years, the Treasury has been reviewing the UK funds regime.  Its aim is to make the UK "a more attractive location to set up, manage and administer funds and to support a wider range of more efficient investments better suited to investor needs".  This review had already yielded some tangible results: in particular, the recent introduction of the Long-Term Asset Fund (LTAF) and the development of a promising new tax regime for qualifying asset holding companies (QAHCs) which will come into force in April.  In addition, the latest announcements confirmed that the government is taking forward a new fund structure, the Professional Investor Fund – which will be welcome news in the real estate funds industry.  However, for most private fund managers, there was not much to write home about.

The government's latest publication follows a "call for input", issued in January 2021, seeking stakeholder feedback on potentially wide-ranging tax and regulatory reforms. The government received input from across the asset management sector, including from Travers Smith, with suggestions ranging from reforms to limited partnership law to recommendations for VAT on fund management fees.  Having considered these responses, the government has now made clear which suggestions it will take forward – and those which it will not.

It is fair to say that a number of helpful initiatives were confirmed in the February announcements. For example, the government remains committed to work that should facilitate uptake of the LTAF. This could be a useful structure for private funds that wish to access capital from defined contribution pension schemes, insurers, and wealthy individuals but – as the government acknowledges – establishment of the structure is only the first step. The ongoing workstreams include assessment of the case for further changes to the tax rules, and regulatory reforms to facilitate distribution to a wider range of retail investors.

In addition, and very importantly for real estate funds, the government says that it will create a new form of unauthorised fund, which would be suitable for professional investors.  This "Professional Investor Fund", advocated by industry experts and associations, will be an onshore closed-ended or hybrid vehicle for institutional investors – but, although available for other underlying assets, it will be mainly of interest to funds holding UK real estate.  The government further confirmed that helpful changes to the rules for Real Estate Investment Trusts (REITs) are also under active consideration, in addition to those already coming into effect next month. 

Meanwhile, many other ideas were put on ice or rejected altogether – perhaps most significantly a suggestion to zero-rate VAT on management fees. Although restating a commitment to publish a consultation on the VAT treatment of fund management fees in the coming months, the government has concluded that it will not go so far as to allow fund management businesses to recover their own VAT while not having to charge it to their UK clients. That means that the rules will continue to incentivise UK fund managers to use non-UK private fund structures over equivalent UK ones – broadly, because doing so allows them to achieve VAT treatment which has a similar effect to zero-rating.

An important suggestion made by the private equity and venture capital industry was for a bespoke tax regime to address the decline of UK-domiciled limited partnership funds, and specific legal reforms to limited partnership law, including the option for limited partnership funds to have legal personality. However, while affirming that it wants to support the limited partnership structure and to ensure that it works efficiently for investors, the government is not proposing to take forward any of these reform proposals at this time – although it says the door is open to further discussion.

The declared intentions of the government are undoubtedly positive for the alternative investment funds market.  Building on the UK's already world-leading financial services sector by making changes to improve the competitiveness of the tax, legal and regulatory environment is a priority.  There is also a clear recognition that private capital is an attractive asset class, offering the potential to boost returns to savers while also contributing to growth in the real economy.  Recent initiatives have demonstrated a willingness to legislate at speed to capitalise on opportunities, and the UK's new holding company regime – which, incidentally, might itself benefit from the latest proposals to require more substance in entities established in the EU – is a good example (although some technical issues still need to be ironed out by the tax authority). 

However, many of the suggestions rejected by the government in this latest review could have made a difference to firms who are looking at their international structures in a post-Brexit world.  It is important that the constructive dialogue continues and that the best of these suggestions live to fight another day. 

Read previous issues of Travers Smith's Alternative and Sustainability Insights.

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At the end of last month, the European Commission unveiled its much-delayed plan to require companies doing business in the European Union to undertake far-reaching sustainability due diligence throughout their supply chain. Heralded by the Commission as "a game-changer" which will "project European values on value chains", the proposal has already drawn fire for not going far enough. Critics have pointed out that the new rules will only apply to the very largest companies, and do not significantly extend directors' fiduciary duties. The Commission has apparently decided that a less ambitious proposal will improve its chances of getting legislation in place quickly – perhaps even by the end of this year.

The proposal will now be negotiated with the Parliament and the Council (made up of the EU's 27 member states) and the final rules will almost certainly change during that process. However, the Parliament and the Council will be supportive: they have both called on the Commission to come forward with this proposal, and some member states – including France and Germany – have already introduced their own supply chain due diligence rules.

Notwithstanding the criticisms, the Commission's proposals are radical because they would require companies in scope, which will include some asset managers and many non-EU companies, to operate an ongoing process to identify – and then prevent, end or mitigate – actual and potential adverse human rights and environmental impacts across their "value chain" (including anyone, upstream or downstream, with whom they have an "established business relationship)". There is also a requirement for some large companies (again, potentially including asset managers) to prepare a plan to ensure that their business strategy is compatible with the goals of the Paris Agreement.

These rules would go much further than, for example, the corporate reporting obligations under the UK's Modern Slavery Act – especially since the Commission envisages that national authorities would monitor compliance and sanction companies who are in default. Much more significantly, outsiders affected by any adverse impacts that were not identified or mitigated as a result of a failure to comply with the law would be able to bring a claim for damages against the company for any losses suffered as a result. That could be a game-changer.

Although the Commission's proposal will directly affect fewer companies than it had originally proposed, it is estimated that around 9,400 public and private EU companies will meet the threshold of more than 500 employees and €150 million net worldwide turnover. In addition, roughly 3,400 EU companies operating in high impact sectors will be caught at a later stage, and thousands of non-EU companies will be caught (including, for example, UK- and US-based alternative asset managers and investment firms) if they meet the relevant turnover threshold based on the extent of their business in the EU.

Of course, this scope understates the impact of the proposal because large companies deal with small companies and those larger companies will, no doubt, look to their suppliers and contractors to help them to discharge their responsibilities – and perhaps shoulder some of the liability risk. In fact, the Directive specifically contemplates that companies should obtain "contractual assurances" from business partners and then verify compliance. When the contract is with an "SME" (a small or medium sized business), the terms must be "fair, reasonable and non-discriminatory" and verification costs cannot be passed to the SME. The Commission has volunteered itself to produce some "guidance" on model clauses.

But, despite these safeguards, there is a risk that large companies will seek to comply with the new law by relying on contractual assurances and verification processes, which are known to have severe limitations in actually mitigating human rights and environmental risks. Any Commission guidance on model clauses would need to align with the shared responsibility principles of the relevant international standards.

One important project, led by the American Bar Association, has already done a lot of that thinking. As their work on model contract clauses makes clear, it is not enough (for example) for a contract to require the supplier to agree to comply with all labour standards in the supply chain, regardless of any external factors, and to be held solely responsible for any breach. Rather, the contract should prioritise shared responsibility for human rights, and put remediation ahead of traditional contract remedies. The European Commission should pay careful attention to this important work as their proposal develops further.

The current draft Directive is also rather light on the specific actions that companies will need to undertake to prevent or mitigate adverse impacts that are identified. That could lead to legal uncertainty – a particular problem given the likelihood that damages claims will be brought against companies by outsiders.

There is still some time to adjust. Although the legislators are keen to get this Directive finalised and adopted quickly, member states will then have two years to get the rules in place (and four years before they apply to smaller organisations).

However, engagement on the detail is needed now in order to shape the final rules. Business organisations and NGOs have already been heavily engaged – and there is more work to do to ensure that the regime is both effective and proportionate.

While there is likely to be significant market push-back to some of the mooted rule-changes which, among other things, challenge well-established and heavily negotiated risk allocations agreed with sophisticated investors, the SEC seems to be signalling that protection of institutional investors is now firmly within its remit. And, importantly, non-US "exempt reporting advisers" (or ERAs) are in scope of some of the most dramatic changes.

Many non-US firms who raise funds from US investors are classified as exempt reporting advisers because they have their principal place of business outside of the US, their only US "clients" are private funds, and all assets managed by the firm from a location in the US (if any) are solely attributable to private funds and total less than $150 million. ERAs must make regular public SEC filings containing a limited amount of information (at least annually), and are subject to a reduced set of SEC rules.

Some of the most controversial proposals made by the SEC – specifically, the changes that are included under the headings "Preferential Treatment" and "Prohibited Activities" – would apply to all private fund advisers, including ERAs, with no grandfathering for existing funds.

The "Preferential Treatment" rule would prohibit certain arrangements with particular investors (for example, in a side letter) that the SEC regards as detrimental to other investors in the fund, such as preferential redemption and transparency rights that would have a “material negative effect on other investors in the private fund”. The Preferential Treatment rule would also require additional disclosure of other preferential terms, with that disclosure being provided pre-commitment to prospective investors, and annually to existing investors.

The proposed "Prohibited Activities" include a range of activities and contractual provisions that the SEC has deemed to be “contrary to the public interest” and would include, for example, a prohibition against any clawback of overpaid carried interest being limited to the net after-tax amount; and a prohibition on indemnification by the fund or its investors for the adviser's negligence.

These and other proposed changes would, if implemented, force a change to market practices in both European and US private funds and would require changes to existing (negotiated) contracts. And, while many of the other changes outlined in the SEC's proposals will only affect investment advisers that are registered with the SEC (and not ERAs), those changes would also add significant additional reporting, disclosure and compliance requirements for those firms.

One change – though not one applicable to ERAs – that has caught the attention of the secondaries community is the proposed requirement for a "fairness opinion" on a GP-led secondary transaction. The SEC claims that this is "an important check against an adviser’s conflicts of interest in structuring and leading a transaction from which it may stand to profit at the expense of private fund investors".  

In fact, of course, fairness opinions are fairly standard in the US (and European) market as a way to manage the unavoidable conflicts of interest that arise on a secondary deal that is initiated by the private equity fund sponsor, including when the manager wants to offer investors an opportunity to continue to hold one or more assets while giving others the chance to achieve liquidity. The fund's LPAC (Limited Partner Advisory Committee) will have a significant role in managing these conflicts; indeed, their consent to the transaction is typically required under the fund's partnership agreement. Since LPACs regularly include representatives from some of the world's largest and most sophisticated investors, it is not surprising that good practices have become industry-standard. Investors also have the benefit of the ILPA Guidance, which is soon to be updated to take specific account of the growth in single asset continuation funds. 

The problem with the SEC's proposed rule, though, is its rigidity: there will be times when a fairness opinion is not needed, because (for example) a current open market valuation of the asset is available. If the LPAC is comfortable with that, it is not obvious what a fairness opinion will add – except an additional cost to be borne by the fund (and, therefore, the investors).

Perhaps more newsworthy, though, is that the SEC appears to be focused on GP-led secondary deals at least in part because it sees them as an indication that a GP is unable to sell assets and, therefore, as a sign of potential trouble ahead. They made this point in a separate consultation, issued at the end of January, on changes to Form PF – the filing required to be made by private fund advisers – proposing that a firm must notify the SEC immediately on completion of any GP-led secondary, rather than when the next filing is due.

While the SEC's view was a common stereotype of GP-led deals in their early days, today GP-led secondaries are often centred around prized assets in which the sponsor sees significant room for future growth. It is not clear how the SEC would be able to tell the difference between a continuation fund deal that signals a difficult market, and one where the GP thinks a crown-jewel asset has significant upside that it does not want to forgo.

All told, these proposed rules, if adopted in their current form, would mark a significant change in regulatory strategy by the SEC and restrict the ability of sophisticated market participants to decide for themselves the rules that should apply to their relationship. Non-US managers that are ERAs, and certainly non-US managers that are registered with the SEC, should pay careful attention to further developments.

We are grateful to Lindsey L. Wiersma, Partner at Paul, Weiss, Rifkind, Wharton & Garrison LLP for help in preparing this edition of Alternative Insights. Further information on the SEC's proposed changes is available here. 

Last year we hosted a webinar on GP-led secondaries. Request a copy of the recording.

This focus on transitioning business through the super-charged engagement that comes with private equity ownership matters. As the Chief Executive of the European industry association, Invest Europe, said recently, the unique features of the private equity and venture capital business model mean that the asset class has a real chance to deliver positive change. That applies to changes that further social and environmental goals just as must as it does to changes that improve financial performance – although, of course, those objectives are increasingly inseparable. Not only is it becoming clear that more capital will flow to asset managers that can contribute to the "just transition", it is also widely recognised that (material) sustainability issues will have a direct impact on risk and on exit value and, therefore, on fund returns.

But the challenges in grasping this opportunity should not be under-estimated. Conscious of reputational and regulatory concerns – and indeed ethical issues – firms are understandably reluctant to sign up to commitments they are not confident they can achieve. Decarbonisation, at least in some sectors and regions, is very challenging, while commitments to invest in climate solutions rely on investible projects being available.

Many private equity and venture capital firms are relatively small and need to invest significantly in the expertise required, both at manager and portfolio company-level. Such investment is certainly in evidence in private markets – and so is guidance that is specifically addressed to private equity. Invest Europe's Climate Change Guide and the private equity specific guidance issued by the SBTi are two prominent examples. Last week saw publication of a consultation draft of another very helpful resource: the IIGCC Net Zero Investment Framework's Private Equity module.

The IIGCC – the Institutional Investors Group on Climate Change – combines over 370 asset owners and asset managers, together speaking for around €50 trillion. The Group launched their Net Zero Investment Framework in March last year, but did not cover private equity. A working group has now addressed that gap, and the draft module is intended to complement the main Investment Framework, giving general partners and limited partners a clear path to committing to Net Zero across the portfolio. The consultation is open until 27 February and the industry may want to weigh in on some of the detail.

The IIGCC Private Equity guidance covers private equity and growth capital, with some recommendations also addressed to venture capital firms. The guidance is designed to be used by investors and by primary funds, but also by funds of funds and secondaries funds – who may find it more difficult to pull the levers needed to fully comply.

Ideally, all portfolio companies would be in scope of the recommendations but, where that is not practicable, firms may scope out certain portfolio companies where the investor does not have "meaningful" influence over the company, where the company does not operate in a "high impact" sector and so long as at least 70% of net asset value or emissions is covered. The latter coverage requirement rises to at least 90% of total portfolio emissions by 2030.

Using criteria laid out in the guide, portfolio companies that are in scope are then put into four categories by the investor: "Net Zero", "Aligned", "Aligning" and "Early progress". Emissions must be measured for each investment and 5-year targets set at fund level with a view to having all companies classified as "Net Zero", "Aligned" or "Aligning" by 2040. There are more demanding requirements for new assets: 100% should be "Aligned" or "Net Zero" by 2030 or, for acquisitions after 2025, within 5 years of investment.

Targets are set and reported on for each fund, and can be re-based and updated to reflect changes in holdings. Annual reporting of emissions and related information is also required.

Where relevant, managers or investors should also set targets for investment in climate solutions, using the EU Taxonomy or equivalent criteria to qualify relevant activities. Funds of funds subscribing to the framework should move towards only investing in primary funds that have set targets using this approach.

The guidance offers a series of recommended actions for LPs and GPs to transition a portfolio and increase portfolio company alignment with the Paris pathway. There is a recognition that LPs have less direct influence over underlying companies, but can have an impact through asset allocations, manager relationships and the selection, appointment and monitoring of GPs. The sponsors themselves, on the other hand, are expected to consider their approach to climate issues when fundraising, when undertaking pre-acquisition due diligence on an investment and through the acquisition process, while holding the asset, and again on exit.

The Guide has been prepared so that it builds on existing methodologies, such as the TCFD and the SBTi, and should allow firms to apply a common approach when claiming Paris-aligned emissions reduction targets. It is a document well worth attention by managers who are evaluating how and when to commit to Net Zero. Although it draws attention to the scale of the challenge, it also offers some very helpful practical guidance and a template for a consistent industry-wide approach.

Participants in the private markets have always been quick to innovate and – since there is little in the world of finance that starts with a blank sheet of paper – that often means taking well-established concepts and repurposing them. For LPs who are seeking to ramp up their private markets exposure quickly, or who want some early liquidity without forgoing the future upside in their private equity portfolio – or simply want to raise further capital to meet a large "uncalled" commitment – accessing the mature funds finance market can be an attractive option. For some, it can be an appealing alternative to a secondary sale of a portfolio of fund interests.

The structure is simple, and already familiar to (among others) managers of funds of funds and secondaries funds: move fund interests to a new vehicle and use them as collateral for a loan. The package of LP positions might be a relatively small bundle of interests in similar funds, or a large, well-diversified portfolio. There are a number of lenders keen to provide capital into this market, because it provides them with private markets exposure at a lower cost of capital and with enhanced down-side protection. These lenders are eager to educate larger fund investors, spanning institutions and family offices, on the availability of these products, which offer relatively cheap, often limited recourse, liquidity on the basis of fairly conservative loan-to-value ratios. Several recent deals have underlined the attractions for LPs with existing exposure to the asset class.

Although these transactions seem superficially straightforward, negotiations will focus on some key terms that differ considerably from portfolio-to-portfolio and provider-to-provider. These terms can have important commercial consequences for the borrowing LP and, potentially, the GPs of the underlying funds. For example, what should happen to distributions received from the underlying funds during the life of the loan facility? To what extent should they be automatically applied to pay down the outstanding borrowings, both in performing and non-performing scenarios? Operationally, to what extent does the LP require such amounts to remain available to fund future capital calls into the secured portfolio or, indeed, to acquire new positions? In what circumstances can distributions be paid out to the investor for use elsewhere, provided that the required loan-to-value thresholds are met?

Lenders will clearly want to undertake legal and commercial due diligence on the portfolio interests, and similar considerations will arise to those that apply on a secondary sale in relation to sharing confidential information about the underlying funds with a third party. Lenders will generally want to review the limited partnership agreements and subscription documents and to build eligibility and concentration criteria for continued funding against each position and further borrowing against newly acquired interests.

One important transaction dynamic that needs to be addressed at the outset is the extent to which the underlying fund GPs need to be involved. Often there will need to be a consent, or at least practical cooperation, in order to transfer the LP interests into a special purpose vehicle (an "SPV"), owned or managed by the existing LP and, perhaps, to the LP granting security over the shares in the SPV. But some of the (usually more difficult) questions include: What happens if the facility goes into default? What material investment events in relation to the underlying interests entitle a lender to call in amounts initially lent? Apart from mandatory prepayment provisions, and locking down the secured accounts into which distributions are received preventing any more leakage to the LP (a 'sit and wait' enforcement strategy), lenders usually also want the right to step in and take the keys to the portfolio (either indirectly by taking ownership of the borrower SPV or, in some cases, relying on specific security over each underlying fund interest in order to allow for a piecemeal exit strategy). In either case, the lender would likely sell the portfolio or individual interests in the secondary market. In respect of these enforcement rights, getting the GP's consent at the outset of the financing arrangement may be more difficult. Indeed, GPs are increasingly more aware of these levered structures when drafting the transfer restrictions contained in their underlying LPAs.

Increasing sophistication among the investors in private equity, and growing appetite for exposure to the asset class, is driving market participants to look for ways to mitigate their long-term exposure to an illiquid asset class and to use the assets they hold to drive returns. Of course, when the underlying assets are themselves leveraged, as with private equity or credit funds, some caution is needed. And not all institutional investors will want to – or be able to – take advantage. But at conservative loan-to-value ratios, this looks like an obvious play for some LPs.

In this scenario, many firms turn to regulatory hosting services.  These are well-established and enable a fund sponsor to enlist a regulated service provider to provide licensing cover for the firm's activities, together with compliance support and oversight. These arrangements are often temporary – to allow a sponsor time to establish its own regulated entity – but can be permanent, especially for smaller fund sponsors. 

In the event, of course, the third country passport wasn't activated in 2015, and still hasn't been – perhaps in part because the UK voted to leave the EU in 2016, and UK-regulated firms could have used the passport to gain access to the single market. Meanwhile, the AIFMD review was duly launched in 2017, when KPMG was commissioned to prepare a report, but it was only last week that concrete reform proposals were issued by the Commission. Both the slow pace of the review and the limited scope of the proposals that have been put forward reflect the Commission's view that the current regime is broadly working well. There has also not been much pressure from industry participants and other stakeholders for dramatic change.

There is still some way to go before any changes become effective, and the European Parliament and Council may yet demand more radical reforms. But, even if only the Commission's current proposals survive, there could be important implications for EU and international firms over time – especially those with structures that rely on delegation.

It was widely expected that the Commission would have something to say on delegation, since many EU-headquartered asset management firms (along with many based in the UK, US and elsewhere) rely on structures in which an EU-regulated fund manager delegates important functions – usually "portfolio management" – to a firm in another financial centre, which may be inside the EU or in a third country. The delegation model is a well-established feature of EU asset management and allows functions to be carried out more efficiently. The AIFMD itself already includes demanding rules on delegation, including a requirement that the EU-regulated principal manager must have the resources and expertise to effectively supervise the delegate, and that it retains enough functions so that it does not become a mere "letter-box". 

As anticipated, however, the Commission's proposals signal a continuing concern that delegation may be over-used. The proposals therefore include a requirement for EU regulators to probe delegation arrangements more thoroughly and to report substantial delegation arrangements to the supervisor, ESMA, on an annual basis, with ESMA reporting to EU institutions every two years on developing market practice. If adopted, the proposed amendments to the AIFMD would also require ESMA to conduct two-yearly peer reviews of measures taken by national regulators to prevent firms becoming "letter-box" entities. That would inevitably increase the (already significant) focus on delegation by national regulators, especially in Luxembourg and Ireland. Moreover, the Commission will review the effectiveness of the AIFMD delegation regime after five years, so it is possible that further changes may be made in future.

Other notable provisions in the draft include a requirement to report more extensive information on fees and charges to fund investors on a quarterly basis. This would include all fees and charges directly or indirectly charged or allocated to the fund, or to any of its investments. While many firms will already provide such information to investors in various forms, they would have to compare their current practice to these new, more prescriptive, regulatory requirements. It also seems highly likely that the revised AIFMD will restrict access to firms under national private placement regimes if they – or the funds they manage – are from a country on an EU list of non-cooperative tax jurisdictions. Although that would not currently be a major issue, some countries could find themselves on that list at relatively short notice.

There are some potentially helpful proposals in the package, including liberalisation of the rules on location of depositaries. Additional powers for AIFMs to originate loans on a pan-EU basis could also be positive – although some in the industry may have concerns about the proposed requirement for loan origination funds to be closed ended and retain some underlying risk. In any event, it remains to be seen whether a pan-EU licence to originate loans will survive scrutiny by those member states who currently regulate lending by funds under national law. 

The market has waited some time for these proposals to emerge, and there will be relief that the Commission has not proposed more fundamental changes. These announcements are, however, only the beginning of the evolution of the EU funds regime – and the final destination is not yet entirely predictable. 

We have published a more detailed summary of the Commission's proposals, which also include some helpful changes to the European Long Term Investment Fund (ELTIF) rules.

For more of our content on alternative asset management, please visit our dedicated online hub.

Glasgow's focus on finance was strategic: enlisting the support of the private sector is seen as critical if governmental pledges are to be achieved.  And while voluntary action is applauded, regulators, especially in Europe, are determined to use their rulebooks to ensure the asset management community is playing its part.  In the EU, the first wave of asset manager regulation is already in force or in active development – and is not without its challenges. But it is only in recent months that the sustainability disclosure rules that will apply to UK-regulated alternative asset managers have started to emerge.

Some asset managers would argue that the benefits of harmonisation across Europe outweigh the opportunities created by divergence, but the British government only partially agrees.  The EU Green Taxonomy, for example, has been endorsed and, with some adjustment, will be used by UK firms.  But in other areas, UK regulators do not feel beholden to EU approaches.  There is a recognition that the EU rules have not entirely hit their mark – at least not yet – and there is a willingness to learn lessons. Indeed, the UK has a close eye on emerging international standards and is tending to prefer those. 

The adoption of mandatory climate-related reporting for companies, asset owners and asset managers is a case in point – the UK has opted for a reporting framework created by the Task Force on Climate-Related Financial Disclosures (TCFD), a body established in 2015 by the Financial Stability Board, whose recommendations have gathered endorsements from organisations across the world.  This reporting framework is designed to provide decision-useful, forward-looking information on how financial risks and opportunities are being addressed by companies and other organisations. Reports have to cover the strategy and governance of climate-related business issues, as well as quantitative disclosure of specific metrics and targets. UK-regulated alternative asset managers with over £5 billion under management (and various other financial market participants) need to get ready to publish these reports in the coming years. For some firms that will be a significant additional level of public reporting, even though many recognise the benefits and are, in fact, already actively engaged – as this week's BVCA report demonstrates. (See our detailed briefing on TCFD reporting requirements for asset managers.)

And this month the UK's regulator unveiled tentative proposals for a disclosure regime that will extend beyond climate-related issues, to include other "sustainability risks, opportunities and impacts". These "Sustainability Disclosure Requirements" (SDR) will use the TCFD framework (with its four core themes) and are intended to apply both at firm-wide and at product (or fund) level.  Two distinct layers of disclosure are envisaged; the first, with basic information aimed at consumers, which could bear some resemblance to the EU SFDR's template disclosures; the second, including more granular information, would be targeted at sophisticated and institutional investors. 

Unlike the EU SFDR, the UK envisages a separate labelling regime. As we have argued elsewhere, one issue with the way the EU has designed its rules is that disclosure obligations vary according to the way the fund is marketed, and that has created a de facto labelling system which could actually mislead rather than inform investors.  The UK proposals may be able to avoid that muddle by starting with a clear objective to have well-defined categories that provide meaningful information about what the product can (and cannot) do.  At the moment, the regulator envisages five labels, three of which would be sub-categories of "sustainable" funds.  Getting the labels right will be hard and comments are sought on the preliminary proposals issued this month.  Industry engagement will be crucial.

No one should be in any doubt that European governments will use regulatory change to drive their policy agenda, and larger alternative asset managers who are not currently collecting climate-related data from their portfolio companies, or reporting other key ESG metrics to investors, will have to step up.  But regulators and firms are at least heading in the same direction, as demonstrated (for example) by recent industry-driven efforts to agree sustainability metrics that GPs and LPs will find decision-useful.

Co-ordination between regulators – especially, in the short term, those in the EU and UK – is vital, even though the UK will not adopt the EU rules.  But it is also important to aim for consistency between industry-led initiatives and regulatory changes.  Otherwise, we will only add to the confusing and growing proliferation of standards, which is both inefficient and potentially counterproductive.

Many of these changes were confirmed in last week's budget, and there were also a few concrete new announcements – but the rules themselves are still mostly in development stage and did not grab the headlines. Instead, the media's focus was on some significant new spending commitments, and the equally eye-catching corporate and personal tax increases that were announced earlier in the year. But several impending regulatory changes will create risks and opportunities for the alternative asset management sector – and will continue to require active engagement with policymakers as the detailed rules are developed.

We already know that there will be sweeping changes to sustainable finance rules – necessary if the government is to achieve its ambition for London to become the world's first "net zero aligned financial centre". Among the many recent announcements were finalisation of the rules for climate-related reporting by large UK private companies, further announcements on a Sustainability Disclosure Regime and Green Taxonomy, swiftly followed by more concrete proposals on the disclosure and labelling regime for asset managers. These will bring strategic opportunities as well as compliance challenges.

But the government's competitiveness agenda extends much further than green finance. For example, the ongoing review of the UK funds regime is progressing and will soon lead to concrete changes. One important aspect of this drive to make the UK a more attractive place to locate a fund is the proposed new regime for asset holding companies. The government's proposals have already been the subject of two consultations, and draft legislation was published yesterday (4 November). This is welcome, and the suite of tax benefits available to qualifying asset holding companies will be generous.

In a related attempt to make it easier for firms to locate in Britain, the Chancellor also unveiled proposals in the Budget that would help firms to move all or part of their structure to the UK: new rules will allow non-UK incorporated companies to re-domicile to the UK, while maintaining their legal identity – something that is not currently possible under UK law. Among other things, these new rules may help firms who want to move holding companies to the UK.

Other aspects of the review of the UK funds regime are progressing more slowly. For example, a review of the VAT treatment of fund management fees, announced in March 2020, is still awaited. That gives the UK an opportunity to implement a more coherent and internationally competitive approach to VAT on fund management fees, but it will be tricky to get the rules right. Last week, the Chancellor confirmed that the government has not forgotten about this, promising that the review will materialise shortly. Also due "in the coming months" is the government's response to the call for input on the broader elements of the UK funds review. (Our response to that call for input is available here.)

Alongside the funds review, the government has been vocal about the need to channel more private sector investment into long-term, and often less liquid, investments. That could be excellent news for private markets and more recent announcements have pushed this policy goal, including finalisation of the rules for the new Long Term Asset Fund (LTAF) last week. That new structure will be available from 15 November, and some managers are preparing to launch an LTAF imminently. One stumbling block, however, has been the cap on fees that applies to so-called "defined contribution" pension schemes and there are mixed views in government – and in the pension funds industry – about how performance fees, common in private funds, should be accommodated in that cap. Conscious of this, the government also confirmed in the Budget that it will consult on options for accommodating "well-designed performance fees", including funds with a standard carried interest structure.

Tax incentives for the right kind of investment are also on the table. For example, following a consultation launched in March, the government has announced some changes to the Research & Development (R&D) tax relief regime. This relief will be reformed to better support cutting-edge research methods by expanding the classes of qualifying R&D expenditure eligible to include data and cloud computing costs. This will, we are told, reinforce the UK's status as a 'science superpower' and was swiftly welcomed by the BVCA, the UK's private equity and venture capital industry association.

These and other ongoing work streams continue a post-Brexit theme of the current UK government: to make the asset management sector more internationally competitive, and to facilitate and incentivise its contribution to the government's policy goals. 

Regulatory change – a key tool to drive that agenda – is going to affect all UK alternative asset managers. Adapting to some of those changes will be challenging, but the good news is that many will create important new opportunities.

We are hosting a webinar for Travers Smith clients on the UK's new asset holding company regime - please register your interest if you would like to join us.

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