ESG regulations pose tough questions for ILS managers: Synpulse’s Smith

The recent Sustainable Finance Disclosure Regulation (SFDR) introduced by the EU poses “significant challenges” and tough questions for ILS fund managers looking to build a green reputation, notes Joel Smith, Associate Partner at Synpulse Management Consulting.

Speaking with Artemis, Smith noted that the regulations will require many fund managers to re-assess key aspects of their operating model.

But for those that do so effectively, they also present an opportunity to be “a first mover and market maker for the shaping of norms and standards for how the SFDR applies to ILS,” he added.

The SFDR came into effect on 10 March 2021 with the aim of promoting transparency in the fast-growing area of environment, social, and governance (ESG) financial products.

The idea is that financial product providers can clearly signal to investors which of their products promote sustainable investment, and at least three ILS fund managers have already declared funds to be within the greenest classifications of these standards.

However, Smith notes that the SFDR was not written specifically with ILS in mind and therefore requires interpretation and also flexibility to accommodate future changes in regulation.

For instance, a common theme behind the most sustainable classifications (Articles 8 or 9) revolves around how insurance creates social value. But while insurance can be viewed as having inherent ESG qualities, this is not a sufficient condition alone to satisfy the guidelines.

As part of the classification, ILS fund managers also need to define and disclose the sustainable objective for the fund, sustainability indicators, binding selection criteria, and other components depending on circumstances.

“Though these public disclosures for Article 8 and 9 classifications present an opportunity to attract ESG-oriented investment, they raise important questions under the surface,” Smith remarked.

“They necessitate that ILS fund managers re-assess key aspects of their operating model to answer new questions such as: ‘What additional data do I need to assess the ESG nature of an incoming transaction? What ESG impact does the incoming transaction have on my overall fund or portfolio? And, how does my SFDR classification change my process for assessing that transaction?’”

What’s more, the loose fit of the regulations to ILS transactions presents issues when it comes to features such as ‘look-through requirements,’ Smith added, which include assessing the ESG qualities of not just the sponsor but also the underlying policies.

This raises further questions around data availability, and fund managers’ responses will depend on not only their interpretation of the SFDR but also on their ESG philosophy and even the feasibility of the requirements.

“Whether an ILS fund manager aims to be a market maker, a box ticker, who addresses the most immediate stakeholder expectations, or a barrel scraper, who only does what the law requires them to do, a solid operating mode needs to be in place,” Smith concluded. “Such an operating model needs to able to support the promises made to investors, regulators, and other stakeholders.”

You can read Smith’s full commentary, alongside our Q2 review of the catastrophe bond and ILS market, here.