Empty Spaces, what are we living for?
Abandoned Places, I guess we know the score, on and on,
Does anybody know what we are looking for?The Show Must Go On, Queen, 1991
As the COVID-19 enforced global lockdown continues with all its associated social and economic impacts, it has forced all of us into considering our priorities and how best to spend our time to maintain our health, wellbeing, and that of our family. Collectively we have watched in awe and admiration as doctors, nurses, and all front-line workers have continued with superhuman dedication to managing the worst excesses of the pandemic.
While the direct impacts on financial regulation are not as dramatic, it is indisputable that the pandemic has spurred an unexpected flurry of regulatory activity and thrown up issues that were not foreseen as we entered 2020. We have flagged areas regulators have afforded some targeted accommodations and leeway to global asset managers recognizing that the current situation we all find ourselves in is far from “business as usual.” Despite these uncertain and unprecedented times, regulators and asset managers are moving forward.
There are three significant areas of global asset management regulation and policymaking which are proceeding regardless of the status of the pandemic:
1. SEC to proceed with Regulation Best Interest
COVID-19 has resulted in the Securities and Exchange Commission (SEC) chairman Jay Clayton issuing several statements about emergency regulatory relief. On a broader basis, there has also been some feisty debate between various commissioners within the agency on whether COVID-19 should be their sole focus for now or whether other issues need addressing also.
Notably, the most recently appointed SEC commissioner, Allison Lee, publicly advocated the stalling of all SEC rule-making not directly related to COVID-19, pronouncing that the commission should “proceed with great caution in considering whether to take regulatory action outside of that called for by the current dire and pressing public health crisis.” , Commissioner Elad Roisman, on the other hand, took a different view stating the SEC’s “commitment to our mission: the SEC will not only protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation in good times — but also in unsettling and uncertain times.”
SEC Chairman Jay Clayton seems to be of the school of thought that believes matters beyond COVID-19 should be dealt with and a recent commitment to implementing Regulation Best Interest (Reg BI) on June 30 is particularly significant. The ramifications are profound: US broker-dealers are already reeling from a tumultuous period and working towards compliance despite significant obstacles to hitting the Reg BI deadline.
The new rule requires brokers to act in the best interest of their retail clients when recommending a transaction or investment strategy. Brokers must also clearly disclose to the client any commissions paid as a result of the transaction. Overall, it is expected that the imposition of Reg BI will change the way broker-dealers recommend investments. One outcome could be an increased usage of ETFs by retail investors as fees and simplicity of strategy become more important areas of consideration across the board.
It should also be noted that several law suits have been filed against the rules’ implementation, including filings by the attorneys-general of seven states — New York, California, Connecticut, Delaware, Maine, New Mexico and Oregon — and the District of Columbia. Another suit suggests that the rule creates an unfair advantage for broker-dealers over competing Registered Investment Advisors who, it argues, remain subject to tougher fiduciary standards.
Earlier this month, SEC Chairman Jay Clayton, said the June 30 deadline remained “appropriate” based on the regulator’s engagement with companies affected by the new rule over the past 10 months. Mr. Clayton added that companies that cannot meet requirements because of the disruptions caused by coronavirus should discuss their situation with the SEC. The outbreak of the coronavirus pandemic as well as the pending lawsuits led some to believe the rule would be delayed. However, it is the general expectation that the existing target date of June 30 will remain.
2. Yes, Brexit is Still Happening
With the pandemic dominating almost every aspect of our lives, Brexit may have lost its place in the news cycle and seem a little less significant than it once seemed. Not so –the sands of time continue to ebb away, and the end of the transition period comes ever closer. Without a deal agreed, there remain several practical difficulties which may have an impact on the global asset management ecosystem.
On March 30, the EU and the UK held their first Joint Committee meeting on the implementation and application of the Withdrawal Agreement, by means of teleconference. Both parties set out their intention to implement their prior agreement “with rigor and discipline.” It was agreed to create six special sub-committees on the various elements of the agreement and that work should begin immediately.
Then, on April 15, the respective chief Brexit negotiators Michel Barnier and David Frost met via video conference to continue the dialogue. What was most notable from this engagement was the lack of headlines after. The major points were that three concrete dates for further negotiating rounds lasting a full week were agreed:
– w/c 20 April
– w/c 11 May
– w/c 1 June
Barnier and Frost will conduct an additional three rounds via videoconference due to the ongoing pandemic, which is notable as the initial plan was for at least nine in person meetings. As such, there is a compressed schedule to agree the finer points of withdrawal in a very condensed period with other now competing priorities created by COVID-19. The next key date in the Brexit diary is the already scheduled High Level Conference in June where Boris Johnson, Ursula von der Leyen (EU Commission President), and Charles Michel (EU Council President) will meet, and this will be the absolute last chance (I know I’ve said that a few times but this one REALLY could be!) to delay or even cancel Brexit.
At this juncture, the specter of a No Deal Brexit looms large.
3. EU ESG Agenda Progresses Undeterred
We recently flagged that the EU is forging a leadership path on the integration of ESG into all aspects of its capital markets. It seems that the imposition of a historic health and economic crisis will not slow the EU’s roll on this agenda. In fact, the opposite is true: the EU has stated that its ongoing sustainable finance agenda highlights the need to strengthen the sustainability and resilience of societies and the ways in which economies function.
The EU has recently issued a double whammy of ESG public consultation. One is wide ranging and focuses on the overall EU ESG strategy, whereas the second one is more targeted and homes in on disclosure requirements. Both are significant.
ESG Disclosure Consultation
This public ESG consultation has been issued and reiterates the intention to stick to its existing timetable despite impacts of the coronavirus pandemic. The consultation paper marks the first stage of the EU’s “renewed sustainable finance strategy’” announced within Ursula von der Leyen’s Green Deal, with the complete framework being expected to be announced later in the year.
The EU appears resolute in its opinion that the financial system is not yet transitioning fast enough and is doubling down on its intention to be a leader on the shift. The consultation paper actually links itself directly to the COVID-19 outbreak, suggesting that the outbreak merely “underscores some of the subtle links and risks associated with human activity and biodiversity loss”.
In terms of specifics, the consultation builds on previous work conducted and incorporates new areas, including:
- Ecolabels for sustainable investment products
- Adjustments to variable remuneration based on ESG parameters
- Observations on the effect of financial advice on retail investors
- Creation of a “brown” taxonomy to supplement the existing “Sustainable Taxonomy”
- Expansion of an asset managers’ fiduciary duty to include consideration of adverse sustainability impact.
Following hot on the heels of the strategy consultation all three European regulators, the three European Supervisory Authorities (ESAs) collectively issued a consultation on required ESG disclosures which lays out the suggested technical standards on already agreed principles for disclosure. Among the key topics here are requirements to divulge any “principal adverse impacts of investment decisions on sustainability factors,” the imposition of a mandatory reporting template as well as more detail on the “do not significantly harm” principle. The detailed document also sets expectations for required disclosures through the lifecycle of investment from pre-contractual, to post investment as well as periodic update requirements.
Initial industry reaction to the standards is that they are hugely detailed and possibly go too far in the level of granular assessment that must be conducted on every single investment. Never before have asset managers been required to drill down into an investible company’s business model to assess whether or not the company has a “deforestation policy” or its “policies on the protection of whistleblowers” as part of their adverse impact calculations.
It is a debate worth watching closely since the level of regulator ambition and the industry’s ability to easily adhere to it seems to be some way apart at this moment. The deadline for responses is 1 September 2020.
Some of the initial observations on the consultation is that there are elements that may go too far. It is important for asset managers to contribute to the debate as the direction of travel is known but the speed and ultimate destination can be influenced. There is a lot more to come on this critical topic of ESG integration. This public consultation remains open until July 15, 2020.
What is clear — regardless of pandemic, remote working environments, and market volatility impacts — is that when it comes to crucial regulatory policy changes, COVID-19 does not guarantee respite. The show is going on.