Portfolio Managers and ESG: A brief overview of the Swiss regulatory landscape

 

By Valérie Menoud 
Partner at the Geneva Office, Lenz & Staehelin 
And François Meier
Associate, Lenz & Staehelin                               

 

Introduction

In recent years, assets under management that incorporate environmental, social and governance ("ESG") criteria have grown significantly. According to a survey conducted by Swiss Sustainable Finance, sustainable investments in Switzerland increased by 30% from 2020 to 2021 to represent a volume of CHF 1,982.7 billion in 2021[1].

This growth has been accompanied by several recent regulatory and self-regulation initiatives aimed at promoting sustainable finance and preventing greenwashing. In the EU, a number of binding directives and regulations have been issued in recent years in relation to sustainable finance, impacting the provision of investment advice and asset management services[2]. By contrast, in Switzerland, the legislature has, for the time being, largely left the topic to the industry, which has, where relevant and required, issued sector-specific self-regulation[3]. The Swiss regulatory ESG landscape is in its early stages. It is, however, expected to develop quickly and significantly in the coming years.

Against this backdrop, the purpose of this article is to provide a brief overview of the key ESG-related Swiss law principles that independent portfolio managers should keep in mind when performing their investment advice and asset management services. We will focus on the integration of ESG characteristics and risks into the investment process and the consequences on the manager's internal risk management processes, before looking at expected future regulatory changes.

 

Investment profile and strategy

1. Integrating ESG issues

Under Swiss law as it stands, portfolio managers are not required to proactively ask a client about whether and which ESG aspects should be integrated into the proposed investment solutions ("ESG Preferences") as part of the mandated appropriateness and/or suitability assessments[4]. Indeed, the appropriateness and suitability checks required under the Swiss Financial Services Act ("FinSA") currently focus on financial aspects, in particular on the client's financial situation, his understanding of risks and his capacity and willingness to bear them.

That being said, even where the client has not set specific ESG Preferences, ESG aspects cannot be left out altogether when advising on an investment or managing a portfolio: Portfolio managers are required, under their contractual duty of loyalty and care, to be mindful of any types of risks that could have a material impact on the value of the investment[5]. This can include ESG-related risks, just as it traditionally includes political, legal or economic risks. Hence, where ESG issues would have an effect on the risks related to the investment, they must be taken into account when assessing the potential risk-adjusted returns of the investment. To be clear, this alone does not impose a duty to pursue an ESG-oriented strategy or assign more weight to a sustainability-related factor, but merely requires including material ESG risks, along with all other relevant factors, in the investment advice or decision.

Of note, in the EU, since the entry into force of Delegated Regulation (EU) 2021/1253[6] on 2 August 2022, mandatory regulation pushes ESG issues further: EU investment firms are required to explicitly inquire about their clients' ESG Preferences in the context of their suitability assessment and to make sure that they do not trade in financial instruments not meeting these stated ESG Preferences.

The new Guidelines on the integration of ESG-preferences and ESG risks into investment advice and portfolio management issued by the Swiss Bankers Association ("SBA"), which will enter into force on 1 January 2023, go in a similar direction, by requiring SBA members to integrate ESG considerations into their investment advice and portfolio management processes. Whilst these SBA guidelines are not binding upon independent portfolio managers, they can serve as useful indications as to the effort and diligence that can be expected when including ESG Preferences in the investment strategy and process at the client's behest. The same can be said, mutatis mutandis, about ASIP's ESG Guide.

2. Addressing the risk of "greenwashing"

Discussions around ESG characteristics, risks or ESG-oriented investment solutions with a client carry certain "greenwashing" risks[7]. Greenwashing can be defined as the practice of (gaining an unfair competitive advantage by) mis-selling or misrepresenting sustainability characteristics and/or risks of an asset or investment solution ("Greenwashing")[8]. In other words, presenting something as "green" or "sustainable" when it is not.

There is currently no dedicated regulatory prohibition specifically addressing Greenwashing under Swiss law. However, questionable practices may fall under the generic unfair business practices prohibition of the Swiss Unfair Competition Act. In addition, greenwashing, as a deceiving behavior, may give rise to civil liability grounds or, even, bear criminal law consequences. From a regulatory perspective, a portfolio manager engaging in greenwashing could see its fitness and propriety questioned by the regulator under Art. 11 of the Swiss Financial Institutions Act ("FinIA").

As a result, portfolio managers need to ensure that they do not engage in Greenwashing at the point of sale, by presenting an investment solution as sustainable when in fact it is not or misrepresenting the ESG characteristics and/or risks of an instrument. This primarily involves taking appropriate internal organization measures, notably by making sure ESG aspects are adequately covered by staff trainings and internal processes and controls (see also below section).

 

Internal organisation, risk management and training

Considering the growing trend towards sustainable investments, portfolio managers need to ensure their staff and processes are equipped to address ESG issues with clients. First and foremost, this requires clearly and transparently informing clients about the manager's capabilities as regards the ESG investment strategies/approaches offered (as the case may be) and their limits[9].

Portfolio managers offering ESG investment solutions, in particular, need to make sure that these strategies, the risk they represent and the additional specialized knowledge they require are adequately covered by their internal processes and integrated into staff trainings (at the level of the front office, as well as at the level of the risk management and control functions)[10]. Adequate ESG risk management also requires considering ESG risks as risk drivers for more traditional risk categories, such as market, operational, legal and reputational risks.

 

Regulatory Outlook

The ESG regulatory environment evolves rapidly, in an effort to further sustainable investments, especially to increase support for the climate transition. Whilst, for the time being, portfolio managers remain subject to a relatively light regulatory regime, largely based on voluntary initiatives, change can be expected in the near future. Key regulatory initiatives to prepare for will likely revolve around the following topics:

  • The integration of ESG Preferences in the investment process: The Swiss Government is currently working on proposals to amend financial market legislation in order to further foster sustainable investment solutions whilst mitigating greenwashing risks. This could eventually lead to a revision of the conduct rules applicable to all financial services providers under FinSA, aligning these rules closer to the requirements set out under EU law or to the SBA's ESG guidelines, as regards the integration of ESG Preferences in the investment process.
  • Greenwashing: Greenwashing will undoubtedly remain at the top of the regulator's agenda and will likely lead to a number of regulatory enforcement action in the future. The issue is likely to gain even more traction with the increasing standardization in the denomination of products and reporting on these products, notably at international and EU level[11], but also in Switzerland (for instance, with the implementation of the Swiss Climate Scores initiative[12]).
  • ESG Reporting: Under the EU's Regulation (EU) 2019/2088 on sustainability‐related disclosures in the financial services sector ("SFDR"), financial market participants are required to disclose (on their website) the policies followed as to the integration of sustainability risks in their investment decision‐making process and, where applicable, the due diligence policies followed with respect to principal adverse impacts of investment decisions on sustainability factors. For the time being, no comparable mandatory disclosure requirements apply under Swiss law. The Swiss legislature may, however, decide to impose similar binding ESG disclosure duties on the asset management sector, in an effort to increase transparency and achieve more comparability.

 

 

Biographies

Valérie Menoud is a partner at the Geneva office of Lenz & Staehelin, where she co-heads the Investigations practice. She primarily advises in banking, capital markets, contractual and corporate matters. She specializes in financial regulation, corporate governance and sustainable finance. She completed her law studies at the University of Lausanne (lic. iur.) and the University of Zurich (Dr. iur.), and is admitted to the Bar in Geneva. She also obtained an LLM degree from Stanford University.

François Meier is as an associate at Lenz & Staehelin and focuses on banking, regulatory, corporate and contractual matters. He completed his law studies at the University Panthéon Assas (Paris II) (double BLaw) and the University of Fribourg (double BLaw; MLaw) and is admitted to the Bar in Geneva. He further obtained an LLM from the College of Europe (Bruges).

 

[1] Swiss Sustainable Finance, Swiss Sustainable Investment Market Study 2022, June 2022, available under this link.

[2] For instance the Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088, OJ L 198, 22.6.2020, p. 13(the "Taxonomy Regulation"), Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability‐related disclosures in the financial services sector, OJ L 317, 9.12.2019, p. 1 (the "SFDR"), Commission Delegated Regulation (EU) 2021/1253 of 21 April 2021 amending Delegated Regulation (EU) 2017/565 as regards the integration of sustainability factors, risks and preferences into certain organisational requirements and operating conditions for investment firms, OJ L 277, 2.8.2021, p. 1 (the " Low Carbon Benchmark Regulation").

[3] See, for instance, Swiss Bankers Association ("SBA"), Guidelines for the financial service providers on the integration of ESG-preferences and ESG risks into investment advice and portfolio management, June 2022, available under this link; see also Asset Management Association Switzerland ("AMAS"), Self-regulation on transparency and disclosure for collective assets referring to sustainability, September 2022, available under this link; Swiss Association of Pension Institutions ("ASIP"), Guide des ESG pour les caisses de pension suisses, July 2022, available under this link.

[4] See FINMA Guidance 05/2021, Preventing and combating greenwashing, 3 November 2021, available under this link, p. 5 et seq. See also Liburn Mehmetaj/Katja Brunner, ESG and Fiduciary Duties of Investment Managers, GesKR, 4/2021, p. 451; Dusan Ivanovic/Yannick Wohlhauser, Sustainable Finance in der Schweiz, GesKR, 2/2022, p. 178. That said, certain authors are of the opinion that even the suitability checks under the Swiss Financial Services Act require to ask about ESG Preferences (Damian Fischer, Greenwashing-Bekämpfung am Point of Sale, GesKR, 2/2022, p. 261). Of note, recently, a few legal scholars have discussed whether a requirement to enquire about the client's ESG Preferences could flow from the contractual duty of loyalty and care under mandate agreement law (see, for instance, Liburn Mehmetaj/Katja Brunner, ESG and Fiduciary Duties of Investment Managers, GesKR, 4/2021, p. 449 et seqq. Martin Eckert/Tamara Teves/Romina Lauper, Nachhaltigkeit und Finanzmarktrecht, GesKR, 3/2020, p. 422 et seq.). As things stand and in the absence of any case law on this very point, this would, however, remain a difficult argument to make in relation to independent portfolio managers in our view as it would require to impose duties that appear not to be applied generally by the profession or the sector of independent portfolio managers (no objective standard) at the moment. That said, this may change in the near future (in particular due to legislation and/or self-regulation).

[5] Dusan Ivanovic/Yannick Wohlhauser, Sustainable Finance in der Schweiz, GesKR, 2/2022, p. 177; Martin Eckert/Tamara Teves/Romina Lauper, Nachhaltigkeit und Finanzmarktrecht, GesKR, 3/2020, p. 421 et seq.

[6] Commission Delegated Regulation (EU) 2021/1253 of 21 April 2021 amending Delegated Regulation (EU) 2017/565 as regards the integration of sustainability factors, risks and preferences into certain organisational requirements and operating conditions for investment firms, OJ L 277, 2.8.2021, p. 1.

[7] This has been pointed out by FINMA in its Guidance 05/2021, Preventing and combating greenwashing, 3 November 2021, available under this link.

[8] Damian Fischer, Greenwashing-Bekämpfung am Point of Sale, GesKR, 2/2022, p. 257.

[9] See information paper published by the VSV|ASG, " Vermögensverwalter und ESG-Aspekte; Die am Point of Sale anwendbaren Grundsätze" (link). See also Urs Bertschinger, Das Finanzmarktaufsichtsrecht vom vierten Quartal 2020 bis ins vierte Quartal 2021, SZW 6/2021, p. 743.

[10] See Art. 9 and Art. 21 of the FinIA; Art. 12(3) and (4) and Art. 26 of the Financial Institutions Ordinance; Art. 6 FinSA.

[11] See in this regard for instance the consultation launched by the European Securities and Markets Authority ("ESMA") on 18 November 2022 on guidelines for the use of ESG or sustainability related terms in funds’ names, available under this link.

[12] More information on this initiative is available under this link.