On 2 June 2022, the European Supervisory Authorities (“ESAs”) provided clarifications on the ESAs’ draft RTS issued under Regulation (EU) 2019/2088 on sustainability–related disclosures in the financial sector (“SFDR”).
Such clarifications concern the draft RTS included in the final report with regard to the content, methodologies and representation of disclosures according to certain articles under SFDR from 4 February 2021 and the draft RTS with respect to the content and presentation of disclosures under the final report of 22 October 2022. The final report covers both of those draft RTS. The application date of the RTS is delayed until 1 January 2023 in order to provide financial market participants and financial advisers with sufficient time to adapt and adjust their practices (this in particular with regards to the product specific disclosures deriving from Regulation (EU) 2020/852, the Taxonomy Regulation (TR)).
The ESAs provide clarification on key areas of the final reports, including principal adverse impact (PAI) disclosures, financial product disclosures and “do not significantly harm” (DNSH) disclosures.
The ESAs’ clarification can be broken down into the following main sub-sections.
- Uses of sustainability indicators,
- PAI calculation methodology,
- Look-through approach and investment instrument scope for PAI disclosures,
- Disclosures for direct and indirect investments in pre-contractual and periodic disclosures,
- Further guidance on the adverse impact indicators in tables 1-3 of Annex I,
- Guidance related to pre-contractual financial product disclosures,
- Guidance related to periodic financial product disclosures,
- Guidance related to taxonomy-related financial product disclosures,
- Guidance related to “do not significantly harm” (DNSH) disclosures,
- Guidance related to disclosures for financial products with investment options.
We will summarise some of the key topics below.
Uses of “sustainability indicators”
The ESAs clarify that the “sustainability indicators” and indicators for principal adverse impact referred to in Article 4 SFDR, and Chapter II and Annex I of the draft RTS in the ESAs’ final reports refer to different disclosures under SFDR.
Sustainability indicators used to measure the environmental or social characteristics or the overall sustainable impact of the financial product is covered under Articles 10(1)(b), 11(1)(a), 11(1)(b) SFDR. However, it is possible to use the indicators for principal adverse impact to measure the environmental or social characteristics or the overall sustainable impact of the financial product.
The ESAs outlined three possible uses of the adverse impact indicators at financial product level:
- Disclosure of DNSH for sustainable investments under Article 2(17): the use of PAI indicators is mandatory to demonstrate that an investment qualifies as a sustainable investment. The PAI indicators to be used are the ones in Table I of Annex 1 and any relevant indicators in Tables 2 and 3 of Annex I. The ESAs consider that using PAI indicators to fulfil the DNSH of SFDR does not require any PAI consideration at entity level pursuant to Article 4 (1) (a), 4 (3) or 4(4) SFDR.
- Disclosure of PAI consideration under Article 7 SFDR: the disclosure of PAI consideration at product level is set out in Article 7 SFDR and is not further specified except for fields in the templates to provide the information required by that Article.
- Measurement of the attainment of environmental or social characteristics and the sustainability related impact (Articles 10(1)(b), 11(1)(a) and 11(1)(b) SFDR: sustainability indicators used to measure the attainment of the environmental or social characteristics may include PAI indicators. The ESAs clarify that the use of the PAI indicators as sustainability indicators to measure the attainment or environmental or social characteristics (for Article 8 funds) or impact of the sustainable investments (Article 9 funds) does not require any prior PAI consideration at entity level (pursuant to Article 4 SFDR) or PAI consideration at product level (pursuant to Article 7 SFDR).
PAI calculation methodology
The ESAs provide additional clarifications in the context of periodic disclosures of financial products as regards the value of holdings to be referred to. While the calculation methodology for the disclosure of principal adverse impact of investment decisions on sustainability factors is set out in chapter II of the RTS, the periodic disclosures for financial products are governed by Article 11 (2) SFDR. Hence such periodic disclosures comply with rules under that later article of SFDR.
The ESAs also give examples of calculation of indicators of GHG emissions when the investee company’s emissions change throughout the reference period and the size of investment in that company evolve too. In that case for the purposes of the disclosures of principal adverse impacts of investment decisions on sustainability factors, the assessment of the impact should be based on, at least, the average of four calculations made on 31 March, 30 June, 30 September and 31 December of a calendar year reference period.
Look-through approach and investment instrument scope for PAI disclosures
With regard to the calculations to be made as part of the reporting on principal adverse impacts of investment decisions under Articles 4(1)-(5) SFDR, the ESAs consider that all investments, both direct and indirect (funds and funds of funds) should be included in these calculations.
Direct investments in “investee companies” are those securities issued by the investee company (e.g. listed and non-listed equities, corporate bonds for instance). Indirect investments cover investment in funds (UCITS or AIFs where applicable, funds of funds or derivatives). Where the investee company is a holding company, collective investment undertaking or special purpose vehicle, information on the adverse impact of the investment decisions of those companies could look through to the individual underlying investments of those companies.
Disclosures for direct and indirect investments in pre-contractual and periodic disclosures.
Financial products that promote environmental or social characteristics or commit to a sustainable objective, could outline in the pre-contractual and periodic disclosures what share of the investments of the financial product is held directly and what share is held indirectly.
The proportion of the investment used to attain the environmental and social characteristics or proportion of investments used to attain the sustainable investment objective should be disclosed in addition to what the purpose of the remaining proportion of investments is. To clarify, this means that this remaining proportion of investments that do not qualify as sustainable should be disclosed so that accurate information on the entirety of the investments made by the financial product is properly disclosed to end investors. In practice for example an Article 9 fund under SFDR should follow at least one sustainable investment objective. That sustainable objective does not necessarily need to be aligned with the Taxonomy Regulation. Hence pre-contractual disclosures should reflect the real / potential fund allocation.
That means (as stated by the European Commission in its SFDR Q&A from July 2021), that financial products that have sustainable investment as an objective should only make sustainable investments (but that could potentially not be aligned to the Taxonomy Regulation) and that disclosure is still required on the amount and purpose of the remaining assets (not aligned) to demonstrate how those do not prevent the financial product from attaining its sustainable investment objective.
Further guidance on the adverse impact indicators in Tables 1-3 of Annex I
ESAs provide, amongst others, clarifications on indicator 6 of table 1 of Annex I, on energy consumption per high impact climate sector, on indicator 8 (emission to water) of same table and Annex, on the average impacts from indicators 12 (gender gap) and 13 (board diversity) in Table 1 of Annex I. They further provide clarifications on the required metrics for the identification of inefficient real estate assets in indicator 18 of Table 1 of Annex I. With regard to non-cooperative tax jurisdictions referred to in indicator 22 in Table 3 of the Annex I, ESAs view is that reference to non-cooperative tax jurisdictions should be understood to refer to the EU list of non-cooperative jurisdictions maintained and updated by the EU council.
Guidance related to pre-contractual financial product disclosures
In addition to the final report published on 22 October 2021, the ESAs also provide guidance on how products that invest in a mixture of environmental and social objectives that vary over time could address the requirements to calculate the minimum proportion of taxonomy–aligned investments. This commitment should be made in the pre-contractual disclosures. If changes to the financial product require an update of that commitment, guidance on when and how to update pre-contractual disclosures can be found in relevant sectorial legislation referred to in Article 6(3) SFDR.
Disclosure of the taxonomy-alignment of the financial product calculated for non-financial investee undertakings by using capital expenditure or operating expenditure instead of turnover should justify how this is appropriate for the product in the pre-contractual document. If change in the strategy of a taxonomy-aligned financial product is done, the need to adapt its taxonomy-alignment KPI to increase the transparency towards investors is key.
Guidance related to periodic financial product disclosures
As stated in ESAs supervisory statement, periodic reports referred to in Article 11(2) of the SFDR must comply with the requirements laid down in that Article from 1 January 2022 irrespective of reference periods.
Guidance related to taxonomy-related financial product disclosures
The ESAs consider that the commitments on the “minimum proportion” of Taxonomy aligned investments are binding. As such penalties for failing to respect such commitments are set out in the sectorial legislation referred to in Article 6 (3) SDFR.
For the avoidance of doubt, only economic activities compliant with Article 3 TR can count toward the representation of taxonomy-aligned activities.
Guidance related to “do not significantly harm” disclosures
The ESAs draft RTS sets out disclosures for financial products ‘sustainable investments’ (Article 2(17) SFDR) DNSH requirements for pre-contractual disclosures, website and periodic disclosures. Such disclosures require an explanation of how the sustainable investment does not significantly harm any sustainable investment objective with reference to “how the indicators for adverse impacts in Table 1 of Annex I and any relevant indicators of Tables 2 and 3 are taken into account”.
Articles 4 and 7 SFDR contain references to how the financial market participant or financial product considers the principal adverse impacts of its investments. Disclosures under Article 4 SFDR are done by the publication of a statement on the principal adverse impacts of investments decisions on sustainability factors referring to indicators in Annex I.
As regards the types of disclosures for DNSH and PAI they apply independently. Financial products making sustainable investments must make DNSH disclosures, whereas the PAI disclosures at financial product level (Article 7 SFDR) apply separately under that article.
DNSH disclosure of the SFDR and under TR does not apply in the same way. To access whether an economic activity qualifies as environmentally sustainable, the TR sets out detailed DNSH activity level criteria under Article 17 TR and in technical screening criteria in delegated acts. In contrast, SFDR sets out this principle for the purpose of assessing at the level of the investment which may qualify as sustainable. It means that to qualify as a sustainable investment under SFDR, an investment in a taxonomy-aligned economic activity must also respect the DNSH principle under Article 2(17) SFDR.