ESAs publish Final Report on draft RTS on the review of PAI and financial product disclosures under SFDR

On 4 December 2023, the European Supervisory Authorities (ESAs) published their Final Report on draft Regulatory Technical Standards on the review of PAI and financial product disclosures in the SFDR Delegated Regulation.

The final report responds to a mandate from the European Commission to review certain aspects of the operation of the Level 2 requirements set out in the Sustainable Finance Disclosure Regulation (SFDR) Delegated Regulation. The draft regulatory technical standards (RTS) contained in the final report follow from the amendments proposed in a joint consultation (Consultation) issued by the European Supervisory Authorities (ESAs) in April 2023. You can read more about this in our earlier article here.

The most significant adjustments include changes to the framework for indicators for principal adverse impact (PAI) of investment decisions on sustainability factors (PAIs), including an extension of social indicators, a new product-level disclosure of greenhouse gas emission reduction targets (GHG emissions reduction) and changes to the product-level disclosures contained in the templates in Annexes II-V of the SFDR Delegated Regulation.

The proposed amendments are intended to enhance the quality of sustainability-related information disclosed under the SFDR Delegated Regulation for more transparent and comparable disclosures. It is however noted in the final report that the ESA’s did not want to introduce any changes in the Delegated Regulation that might pre-empt the European Commission’s general assessment of the SFDR (of which you can read more about here). By way of example, on this basis the ESAs have decided not to make changes on the do no significant harm (DNSH) element of sustainable investment (other than the changes outlined below).

Below we summarise the four key elements of the final report on the draft RTS.

PAI framework

The revised RTS propose several new indicators for PAIs, focusing on social impacts, which were not as comprehensively covered in the SFDR Delegated Regulation as the environmental indicators.

The ESAs’ approach in terms of the extension of the list of social indicators for PAIs is to rely primarily on the Delegated Act on the European Sustainability Reporting Standards (ESRS) published by the European Commission in August 2023 under the CSRD. The ESRS will be applied by all companies under the scope of CSRD, thus reducing the burden of disclosure and ensuring coherence between legislation. In addition to the social indicators reported in the ESRS, certain additional mandatory indicators currently not reported under ESRS, but required under the benchmark regulations or available in financial reporting, have been included by the ESAs.

The ESAs have made technical adjustments to other opt-in social indicators in Table 3 of Annex I of the Delegated Regulation.

The ESAs have also included changes to PAI indicators for environmental adverse impacts. These adjustments include, among others, a modification of the way that Taxonomy-aligned gas activities are exempted for the PAI indicator of ‘exposure to companies active in the fossil fuel sector’. Also, there are no changes to the current real estate indicators, but the ESAs have provided some context for when real estate assets can be “storage” for fossil fuels in their feedback analysis.

Other changes to the PAI framework include:

1. No change to the basis on which the PAI indicators are calculated in the current SFDR Delegated Regulation on “all investments” (rather than “relevant investments”), to avoid pre-empting the Commission’s general assessment of  the SFDR and to avoid hampering historical comparison of PAI values by a change to the calculation basis.
2. Disclosure of the share of the PAI based on data from investee companies and the share that is estimated (or reasonably assumed) should be required (reflecting what is currently best practice pursuant to Q&A IV.5 in the consolidated SFDR Q&As).
3. Derivatives should be converted to economic exposure including where derivative transactions do not result in a physical exposure to the underlying.
4. Value chains of investee companies only need to be included in the PAI calculations where the investee company reports on that value chain.

DNSH disclosure design options

The ESAs are concerned that financial market participants (FMPs) currently have a wide discretion when designing the DNSH test for sustainable investments, thereby increasing the risk of greenwashing from differing DNSH test methodologies. However, considering the potential future changes coming from the Commission’s consideration of the DNSH element of sustainable investments in its general assessment of the SFDR, the ESAs have not made any revisions to the SFDR Delegated Regulation.

Nevertheless, given the support in the Consultation feedback for slightly more specific disclosures about how financial products “take into account” PAI indicators for the purpose of the DNSH principle for sustainable investments, the draft RTS include a requirement to disclose the thresholds or criteria for the PAI indicators that the financial product uses to determine that sustainable investments comply with the DNSH principle in the website disclosure.

In addition, the revised RTS would confirm that any investments in taxonomy-aligned economic activities are automatically considered sustainable investments (clarified by the Commission’s Q&A issued in June 2023).

GHG emissions reduction targets amendments

The draft RTS incorporate new disclosures provided in pre-contractual documents, on websites and in periodic reports on GHG emissions reduction targets, including intermediary targets and milestones, where relevant, and actions pursued. For products without such targets, the new set of disclosures will not apply.

Similar to the proposals in the ESA’s Consultation, the new disclosures apply to products having GHG emissions reduction as their investment objective under Article 9(3) SFDR. For products that passively track EU Climate Transition or Paris-Aligned Benchmarks, simplified disclosures apply whereby compliance is achieved by providing (1) a short summary of how ESG factors are reflected in the benchmark tracked by the product and (2) a hyperlink to a description of the Benchmark methodology.

Changes to disclosures

Based on stakeholders’ feedback, consumer testing and supervisory work, the Article 8 and Article 9 SFDR templates contained in Annexes II to V of the SFDR Delegated Regulation have been updated by simplifying the language, restructuring the information provided to avoid repetitions and removing the green colour in all disclosures other than the Taxonomy graphs.

As proposed in the Consultation, the ESAs have replaced the current tick-box with a dedicated “dashboard” in the first page of the documents. The dashboard highlights whether a financial product has a sustainable investment objective or promotes environmental/social characteristics and contains four essential elements:

• Sustainable investments
• Taxonomy-aligned investments
• PAI consideration
• GHG emissions targets (separate to specific disclosures in Annexes III and V for financial products that have a decarbonisation objective under Article 9(3))

The dashboard replaces the existing asset allocation table which will no longer be required.

The new templates have been designed for electronic delivery, with the financial product disclosures  extendable by click, based on the information provided in the “dashboard”. Disclosures which will be made available on the European Single Access Point (ESAP) should be made available in a format which is at the same time human readable and machine readable.

Other notable changes:

• financial products have to disclose whether sustainable investments are calculated at the economic activity level or investment level in their pre-contractual, website and periodic disclosures
• the dashboard requires an express statement to the effect that a product does not commit to making sustainable investments, or EU Taxonomy-aligned investments, if the minimum commitment to make sustainable investments, or EU Taxonomy-aligned investments, is equal to zero
• when applying PAIs to sustainable investments, a brief description of the criteria and thresholds used for that assessment would be required in the PCD with a link to detailed information provided online. This effectively codifies existing level 3 guidance
• an obligation to explain why PAIs were not considered by the financial product where the FMP has considered PAIs of investment decisions on sustainability factors
• as outlined above, new disclosure obligations in relation to GHG emission reduction targets where relevant
• Article 8 and Article 9 SFDR products that commit to not invest in fossil gas and/or nuclear energy related activities that comply with the EU Taxonomy must disclose this
• the new PCD removes the requirement to disclose how sustainable investments are aligned with the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights.

Website product disclosures

The draft RTS include numerous references to enhanced website disclosures, including:

• a requirement to disclose the thresholds or criteria for the PAI indicators that the financial product uses to determine that its sustainable investments comply with the DNSH principle
• for active products, further details in respect of GHG emission reduction targets as well as a description of the actions planned to achieve the target (eg binding elements of the investment strategy, a summary of the engagement plan) and also including eg the GHG accounting and reporting methodology, the proportion for which data on GHG emissions was based on investee undertakings, estimates or from third parties, and where relevant, information on carbon credits and progress towards the GHG emission reduction target
• a requirement to include the “dashboard” that represents the first page of the pre-contractual disclosures in the summary section of the financial product’s website disclosure

Next steps

The Commission will scrutinise the draft RTS and decide whether to endorse them within three months. The revised RTS would be applied independently of the comprehensive assessment of SFDR announced by the Commission in September 2023 and before changes resulting from that assessment would be introduced.

The draft RTS does not provide a proposed effective date for the changes. Once published A&L Goodbody will be working together with other industry participants to agree a process and timeline for updating pre-contractual disclosures with the Central Bank of Ireland.

Fund managers should closely monitor these developments as preparation time will be required to implement the amendments to existing practices and disclosures arising from the proposed revised RTS.

For more information on this topic please contact any member of A&L Goodbody’s Asset Management and Investment Funds’ Team.

Date published: 08 January 2024