How to Run Sustainable ETFs

Investors and all relevant parties involved in the value chain of ETFs¹ must have an understanding of how the SFDR affects them, yet they also need to evaluate how the entire value chain is affected. This may be the only path towards achieving the actual goals of the Sustainable Finance and the Green Deal and helps to ensure a compliant environment, while avoiding greenwashing. Arriving at this understanding is no simple task for asset managers and some insights directly from the legal department of a global asset manager, like VanEck, on how to approach the current situation may help the practical implementation of a compliant and supportive set-up.

What is the Current Situation?

The status quo can be summarized as: Work in Progress.
Financial market participants are struggling to understand how to reach full compliance with the current framework, while also trying to address the major challenges of, and deficiencies in, the relevant regulations. Most importantly, they are waiting for clearly-defined directions from the European regulators and member state authorities.

How Should One Approach the Current Situation?

It is important to find a way through the jungle of running, maintaining, and managing sustainable investment funds and implementing the related legal, operational and risk requirements. Not least because doing so involves investors, all internal departments of the asset manager and all other parties in the value chain of an investment fund and especially an ETF. Other parties include, in particular, wealth managers and other fund selectors, stock exchanges, brokers, authorized participants, index providers, custodians, depositaries, regulators, auditors and accountants.

Navigating through the ESG “shoal” of regulations and updates requires constant effort on the part of all those involved. After some years of dealing with the seemingly endless succession of ESG-related regulations and different approaches to the sustainable investments world, here are some experience-based considerations:

1. Be up-to-date and responsive: The regulatory bodies are now responding promptly to growing concerns about sustainability, corporate responsibility, sustainability risks considerations and investors´ rights and interests. Also, in some European countries, the regulators are currently interacting directly with asset managers to verify the compliance of their products with the Sustainable Finance Disclosure Regulation.
   Being informed on the latest ESG-related regulations in different jurisdictions, as well as being responsive to regulatory updates, guidelines and industry practices, is the most important task. Up-to-date research on ESG and sustainability matters, together with participation in the relevant meetings, webinars, workshops offered by regulators and in other industry´s events are key.
2. Conduct due diligence on ESG service providers: To provide stakeholders with accurate information, asset managers should ensure the reliability of the ESG data used to tailor their products, but also monitor that the ESG data providers have proper processes and methodologies. This will be facilitated by the upcoming regulation on ESG rating activities when it is enacted².
3. Assess materiality and mitigate sustainability risks: Asset managers who integrate sustainability factors into their investment decision-making processes should consider factors that can positively or negatively affect investments. Also, incidents related to sustainability integration could affect the reputation of a company, impacting its market value and, at the same time, the returns for the investors. In addition, incidents related to sustainability integration could also affect the reputation of a company, as prominent examples have shown, impacting its market value and, at the same time, the returns for the investors.
4. Allocate resources and provide training to the relevant departments: in-house resources, establishing a dedicated ESG team and ad hoc trainings, can help ensure awareness, expertise and responsibility within an asset manager´s structure. As the regulation is constantly evolving, resources could also be allocated to establish a system which monitors industry updates, amendments, new guidelines and regulations. Great importance has recently been assigned to the marketing materials and the legal documentation of financial products.
5. Report regularly: A comprehensive and accurate ESG reporting framework enhances transparency and credibility. Regular reports on ESG issues, other than being a regulatory requirement nowadays, are important for meeting investors’ and intermediaries´ expectations and facilitating external feedback. This may lead to a quality improvement with regards to the integration of sustainability factors in the decision-making process.
6. Conduct periodic reviews: Regular gap analysis allow for a timely identification of areas where improvements are needed and for a prompt alignment with the most up-to-date ESG regulatory requirements and best practices. Considering the frequency with which new ESG issues and concerns arise, periodic internal reviews allow material ESG risks and opportunities to be promptly identified and addressed, while proving good governance.
7. Implement suitable policies and procedures: Developing internal policies and procedures which address identification, assessment and mitigation of ESG risks, as well as how develop and monitor ESG-related opportunities, can help demonstrate the commitment to seek, achieve and maintain the highest standards of integrity and transparency on ESG matters.
8. Engage with stakeholders: Meeting and interacting with clients and other stakeholders is key for understanding their perspectives, concerns and expectations. Feedback can help shape internal decisions and strategies and build collaborative and trusted partnerships.

Complying with the ever-evolving regulatory landscape is crucial. Nonetheless, the accurate integration of sustainability factors into financial strategies must not be seen only as a compliance exercise, but also as a significant means of embracing the most important current global challenges, by efficiently enabling the allocation of financial resources into investments which promote positive Environmental, Social and Governance outcomes.