Sustainable Finance Disclosure Regulation: What to expect?
The EU’s Regulation on sustainability-related disclosures in the financial sector (the SFDR) was published in December 2019 and is part of the EU’s package of measures relating to Environmental, Social and Governance (ESG) issues. The SFDR sets out sustainability disclosure requirements applicable to a broad range of financial market participants, financial advisers and financial products. The vast majority of the SFDR requirements begin to apply as of March 10, 2021.
The SFDR [i] addresses two categories of financial market players, the so called financial market participants[ii] (FMPs) and financial advisers (FAs)[iii]. These include certain insurers and insurance intermediaries, UCITS management companies, MiFID firms providing the service of portfolio management, or AIFMRs. FMPs and FAs are required to make pre-contractual, website and periodic disclosures of specified information on how they integrate sustainability risks, on the consideration of adverse sustainability impacts in their process and on the provision of sustainability-related information with respect to financial products.
The SFDR further introduces three new concepts through the specific definitions of “sustainability risk”, “sustainability factors” and “sustainable investment”.
“Sustainability risk” is an environmental, social or governance event or condition that, if it occurs, could cause a negative material impact on the value of an investment.
“Sustainability factors” are environmental, social and employee matters, respect for human rights, anti-corruption and anti-bribery matters.
“Sustainable investment” is an investment in an economic activity which contributes either to an environmental objective or a social objective, provided that such investments “do not significantly harm”[iv] any of those objectives and the investee company follows good governance policies.
Exactly what information needs to be disclosed, and how it is to be disclosed will be to a great extend determined by the Level 2 Regulatory Technical Standards (RTS) that the European Supervisory Authorities (ESAs) are empowered to develop. On 4 February 2021, the ESAs delivered to the European Commission (EC) the Final report, including the draft RTS on the content, methodologies and presentation of disclosures under the SFDR.[v] These RTS are yet to be adopted as acts of the EC; still, the EC has previously confirmed in a letter [vi] to the Chairs of the ESAs that, while the implementation of the SFDR Level 2 RTS will be delayed to a “later stage”, the application of the SFDR is not conditional on the RTS’s formal adoption and entry into force. Thus, the SFDR Level 1 requirements will be legally binding on 10 March 2021, even if certain provisions require Level 2 RTS support. FMPs and FAs will, at that point, need to comply with its “high level and principle-based requirements”. The delay of Level 2 RTS raises practical challenges for in-scope entities – in particular, how to comply with the Article 4 principal adverse impacts regime, and the Article 8 and Article 9 product disclosure regime for light green and dark green products, given the lack of detailed technical standards. In practice, the FMPs and FAs may also face the challenge in view of the need to adopt a two-step compliance – first to update disclosures under the SFDR by 10 March 2021 in a high-level and principles-based manner and, second, to update again by January 2022 (or such other deadline as is specified for the application of the Level 2 RTS) to reflect the formal disclosure requirements of the RTS.
The SFDR key disclosure obligations. Required actions
The in-scope entities key obligations under the SFDR can be presented in three separate groups:
- Website disclosure obligations at entity-level (applies from 10 March 2021)
- FMPs and FAs need to formulate a policy on the integration of sustainability risks in their investment decision-making process, respectively in the case of FAs in their investment advice or insurance advice.
- FMPs must make a choice to either:
(i) implement a due diligence policy with respect to the principle adverse impacts of their investment decisions on sustainability factors at the level of the entity; or
(ii) explain the reasons why they do not consider such adverse impacts, and provide information, where relevant, as to whether and when they intend to consider such adverse impacts.
The SFDR sets forth similar obligation for FAs.
3. FMPs and FAs need to update their existing remuneration policies to include information on how the policy is consistent with the integration of sustainable risks.
- Disclosure obligations at product-level (including products without ESG objective)
4. By 10 March 2021, FMPs must choose for each financial product that they make available to clients, whether to:
(i) asses the likely impacts of sustainability risks on the returns of each financial product and include description of the assessment in the pre-contractual disclosure (including description on the manner in which sustainability risks are integrated into their investment decision, i.e. information disclosed under 1 above); or
(ii) explain in the pre-contractual disclosure why they do not consider sustainability risks to be relevant to a particular financial product.
Similar requirement for pre-contractual disclosure apply to FAs with respect to each of the products they advise on.
5. Depending on whether the FMPs have implemented a due diligence policy under 2(i) above they have either to:
(i) by 30 December 2022, make a pre-contractual disclosure on whether and how each financial product considers the principal adverse impact on sustainability factors (in the case a due diligence policy is implemented);[vii] or
(ii) by 10 March 2021, make a negative pre-contractual disclosure that they do not consider adverse impacts and provide reasons for not doing so (in the case a due diligence policy has not been implemented).
6. By 10 March 2021, FMPs and FAs need to review their marketing communications and ensure that they do not contradict the information disclosed under SFDR.
- Obligation for disclosure for products with ESG focus or objective (website, pre-contractual and periodic disclosure)
Additional disclosure is required where a financial product:
7. promotes (among others) environmental or social characteristics (and investments follow good governance practices). FMPs and FAs must disclose certain prescribed information on how those characteristics are met and on any index designated as a reference benchmark.
Additional disclosure requirements in this respect stem from the Taxonomy Regulation.[viii]
8. has sustainable investment as its objective. FMPs and FAs must disclose certain prescribed information depending on whether or not an index has been designated as a reference benchmark. Additional disclosure requirements will apply under the Taxonomy Regulation if the product invests in an economic activity that contributes to an environmental objective.
9. has a reduction in carbon emissions as its objective. FMPs and FAs must disclose certain prescribed information in relation to the Paris Agreement.
The deadline for website and pre-contractual disclosure for products with ESG focus or objective is 10 March 2021, while for commencing periodic disclosures is 1 January 2022.
Viewed from the above, it is clear that the ESG-disclosure importance will only rise in the future. The legal framework is evolving quickly in this area. In-scope entities will have to review existing procedures and policies, as well as amend and expand them to satisfy the new ESG requirements. They will also need to consider how the new ESG requirements affect their operations and ensure obtaining of quality data from portfolio companies.
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[ii] According to Art 2(1) of SFDR, FMPs are: “(a) insurance undertakings making available an insurance‐based investment product (IBIP); (b) credit institutions and investment firms, offering portfolio management services; (c) institutions for occupational retirement provision (IORP); (d) manufacturers of pension products; (e) alternative investment fund managers; (f) pan‐European personal pension product (PEPP) providers; (g) managers of qualifying venture capital funds registered in accordance with Article 14 of Regulation (EU) No 345/2013; (h) managers of qualifying social entrepreneurship funds registered in accordance with Article 15 of Regulation (EU) No 346/2013; (i) UCITS management companies.
[iii] Art 2(11) of the SFDR lists the following FAs: “(a) insurance intermediaries, which provide insurance advice with regard to IBIPs; (b) an insurance undertaking which provides insurance advice with regard to IBIPs; (c) credit institutions which provide investment advice; (d) investment firms, providing investment advice; (e) AIFMs, which provide investment advice in accordance with point (b)(i) of Article 6(4) of Directive 2011/61/EU; or (f) UCITS management companies, which provide investment advice in accordance with point (b)(i) of Article 6(3) of Directive 2009/65/EC.
[iv] Art. 25 of Taxonomy Regulation (Regulation (EU) 2020/852) amends SFDR to cast light as to what “do not significantly harm” means in practice. As per the new Art. 2a of SFDR, such detail will be specified in the ESAs’ RTS.
[vii] Art. 7(1)(b) of SFDR requires FMPs to include, in the case of 5(i) above, in the pre-contractual disclosure a statement that information on principle adverse impact on sustainability factors will also be available in the periodic reports for the product. Although there is no express provision to include the information under 5(i) above in the periodic disclosure (ref. Art. 7(1) of SFDR), it may be argued that Art. 7(1)(b) of SFDR contain such obligation, as it requires the inclusion of that statement in the pre-contractual disclosure.
[viii] Available here: https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=celex%3A32020R0852 .