The momentum behind protecting the planet and moving towards social justice is growing, and investors are playing a huge part in funding this transition. In recognition of this, the Luxembourg government recently announced a tax incentive to encourage even more investment in environmentally sustainable funds—a reduction in the subscription tax. But how do you know if your investment fund qualifies? Read on to find out.
Why is the Luxembourg government reducing the subscription tax on funds with environmentally sustainable investments?
A wave of new regulation will soon hit EU investments funds, introducing more stringent rules around sustainable investments. Read more about them here.
Complying with the rules will likely mean additional costs for fund houses, and governments are looking to support them so as not to discourage investments in these types of funds. That’s why the Luxembourg government is making this announcement now — to help ensure that ESG funds remain competitive despite the increased regulatory burden. And, in doing so, the Luxembourg government helps Luxembourg keeps its leading position on sustainable investments.
What did the government say in their announcement?
The reduction in the annual subscription tax rate will be granted to UCIs, and compartments of UCIs, investing in any kind of economic activity that qualifies as environmentally sustainable as per the EU’s Taxonomy Regulation (henceforth “environmentally sustainable activities”). The reduction enters into force on 1 January 2021. During a transition period, while a new IT system is developed, funds are being asked to submit reports to
How do I know if my funds qualify?
If you’d like your investors to benefit from the reduction, the first step is to get your funds certified by an external auditor. They’ll check the proportion of net assets invested in environmentally sustainable activities. This is calculated on the last day of the fiscal year, and the reduction is only granted to funds that have invested between 5% and 50% of net assets in activities that qualify. One very important point to look out for: the reduction only applies to the part of the fund judged environmentally sustainable, and not to the entirety of the fund.
How large is the reduction in subscription tax for ESG funds?
The subscription tax rate will decrease to between 0.01% and 0.04% depending on the total net assets invested in environmentally sustainable funds.
Environmentally sustainable refers to any kind of economic activity that qualifies as environmentally sustainable as per the EU’s Taxonomy Regulation.
The reduction only applies to the part of the fund judged environmentally sustainable, and not to the whole fund.
How does the EU Taxonomy define environmentally sustainable funds?
For the EU, environmentally sustainable funds must meet the following criteria:
- Make a substantial contribution to one of the six environmental objectives listed below
- Do not cause significant harm to all remaining environmental objectives (under the “Do Not Significant Harm”, or DNSH, principle)
- Meet minimum social and governmental safeguards.
The EU’s six environmental objectives are:
- Climate change mitigation
- Climate change adaptation
- Sustainable and protection of water and marine resources
- Transition to a circular economy
- Pollution prevention and control
- Pollution and restoration of biodiversity and ecosystems
According to the EU regulation, two types of economic activities can have substantial contribution:
- Economic activities that make a substantial contribution based on their own performance
- Economic activities that enable a substantial contribution to be made by other activities.
Are investments funds ready to give the information required to benefit from the reduction?
This is the rub. The vast majority of funds don’t yet capture the information they need to demonstrate taxonomy alignment so they’re not yet ready to apply for the reduction to their funds. To get prepared, they’ll need to adapt both due diligence and reporting processes and even change the investment culture itself, to look beyond financial performance at environmental impact and positive contributions.
The first to benefit from the reduction will likely be UCIs with an environmental impact investment strategy, or those that invest in green activities. The simple reason is that they are more likely to have the information required to get audited and certified.
Is there enough information available from the EU on the kinds of information that funds should collect?
Regulatory reporting frameworks are still in development. But until standardized and taxonomy-aligned reporting practices are in place, asset managers will find it difficult to identify taxonomy-aligned environmentally sustainable investments. Even when the frameworks do become available, the journey doesn’t stop there as the industry will need to understand, adapt and improve report quality.
This challenge is very similar to that seen twenty years ago, when the initial push for stringent financial reporting began. However, this time the EU is united in its desire to accelerate the process by increasing transparency in upcoming regulation.
What can fund houses do today to accelerate the process.
The reduction in the subscription tax is an important first step from the Luxembourgish government. Financial market participants are given the opportunity to explore and strengthen the development of ESG products while benefiting from financial support, and we applaud this wholeheartedly.
We have been working with client to demystify the upcoming regulatory challenges and find concrete ways to move forward, despite areas of ambiguity. If you’d like to find out how can you dive in today, and thrive tomorrow, contact me on +352 22 51 51 7545 or +352 621 87 7545.
The background story: more about the wave of sustainable finance regulation
In March 2018, the EU commission published an Action Plan on Financing Sustainable Growth. The idea behind the plan was to put an end to greenwashing once and for all. Investors just aren’t getting the information they need about sustainable funds, whether it be how on impact, contribution, or how non-financial risks are assessed. The new action plan, once live, will help remedy this.
In parallel, reporting requirements for sustainable funds are also becoming more stringent. The European Union’s new Sustainable Finance Disclosure Regulation (SFDR) – also known as the Disclosure Regulation – will come into effect March 2021. This regulation lay out new transparency obligations and reporting requirements for asset managers at both a product and manager level.