Introduction
The Sustainable Finance Disclosure Regulation (Regulation 2019/2088, ‘SFDR’) and the Taxonomy Regulation (Regulation 2020/852) were introduced by the European Commission as core parts of the ‘Sustainable Finance Action Plan’. These regulations aim to (i) improve transparency in the market for sustainable investment products and (ii) prevent greenwashing.
The main provisions of the SFDR became applicable on 10 March 2021. Containing more precise disclosure standards, the SFDR Delegated Regulation (Delegated Regulation 2022/1288) was adopted on 6 April 2022 and became fully applicable on 1 January 2023 (except for the first Principal Adverse Impact (‘PAI’) statements, which are due no later than 30 June 2023).
Although the SFDR Delegated Regulation recently entered into force, the European Commission has already mandated the European Supervisory Authorities (‘ESAs’) to review and revise the rules laid down in the SFDR Delegated Regulation. Therefore, the ESAs have launched a consultation with the aim to review the SFDR Delegated Regulation. This consultation is particularly relevant for financial institutions which offer financial products with an investment component to end investors, such as credit institutions, alternative investment fund managers and investment firms. The deadline for comments is 4 July 2023.
In this contribution, we will summarise the most relevant topics of the consultation:
- PAI framework
- The ‘do not significantly harm-principle’
- Decarbonisation
- Simplification and other adjustments
PAI framework
Extension of the list of social indicators
The ESAs proposed a set of four new mandatory and six opt-in social indicators for financial market participants to determine their principal adverse impact. The new mandatory indicators are:
- amount of accumulated earnings in non-cooperative tax jurisdictions
- exposure to companies involved in the cultivation and production of tobacco
- interference in the formation of trade unions or election of worker representatives
- share of employees earning less than the adequate wage
The opt-in indicators relate to use of non-guaranteed-hour employees, temporary contract employees and non-employee workers, insufficient employment of persons with disabilities, and lack of complaint mechanisms.
Technical revision
The ESAs have proposed new formulas and clarifications to definitions and concepts for some of the PAI indicators to achieve greater clarity.
The ‘do not significantly harm-principle’
Under the SFDR, a sustainable investment may not significantly harm any environmental, social or governance objective. However, the SFDR leaves room to financial market participants to determine the requirements an investment must meet to be considered sustainable investment and how they disclose it. As these requirements can be applied differently, it undermines the comparability of the financial products and their underlying investments for investors. This could potentially lead to greenwashing.
Therefore, the ESAs seek input on several alternatives in the consultation: keeping the provisions in the SFDR Delegated Regulation unchanged, providing more specific disclosures and introducing an optional safe harbour for environmental do not significantly harm of Taxonomy-aligned activities.
Decarbonisation targets
Disclosure framework
As many financial products already focus on decarbonisation and the financial institutions offering these products have made net-zero commitments, an increase in financial products relating to decarbonisation and climate change are anticipated. The ESAs are required to propose amendments to the information provided on decarbonisation (i.e., greenhouse gas emissions reduction targets) of financial products in pre‑contractual documents, on websites, and in periodic reports.
In this context, the ESAs propose a different disclosure structure:
- Pre-contractual documents should provide simplified disclosures on the type of outcome the product is committing to achieve and the level of ambition of the target(s)
- Periodic reports should provide additional simplified disclosures on progress to date, explain how the investment strategy contributed to such progress, and identify potential delays in achieving the target(s) and potential adjustments needed
- More detailed disclosures should be available on the website and complement pre-contractual and periodic disclosures. Cross-references to the website should be included in both the pre-contractual documents and the periodic reports
How is the target achieved?
The proposed changes in the consultation include clarifications on the nature of commitments made by financial market participants in their decarbonisation efforts. The objective is that financial products deliver what investors expect and that investors understand clearly what the investment strategy can help achieve. Therefore, the financial market participants would be required to indicate whether they achieve their target of decarbonisation by either divesting and reallocating assets or by investing in assets that deliver decarbonisation over the duration of the investment.
Carbon credits
The ESAs (and recently the Dutch Authority for Financial Markets (Autoriteit Financiële Markten)) question the use of carbon credits in the net-zero mission. The use of carbon credits can give rise to greenwashing concerns. The aim of the commitment to net zero under the Paris Agreement is to reduce emissions as much as possible and to use offsets only for residual hard-to-abate emissions. Because offsetting capacity is scarce, credits should not be used for avoidable emission.
In this context, the ESAs states that the use of greenhouse gas removal techniques and carbon credits should not be considered and disclosed to investors as means to achieve reduction of greenhouse gas emission. Therefore, the ESAs suggest that financial market participants report separately on their investments’ greenhouse gas emission, greenhouse gas removal and use of carbon credits. In addition, if the financial market participant directly finances greenhouse gas mitigation projects (by using carbon credits), it is proposed to separately disclose the use thereof as well.
Simplification and other adjustments
The annexes of the SFDR Delegated Regulation include several financial product disclosure templates. These templates have been criticised for their excessive length and complexity. Therefore, the ESAs also want to consult several simplifications of these templates.
Furthermore, the ESAs aim to address several technical issues relating to, among other things:
- the treatment of derivatives
- the presentation of information
- delivery of pre-contractual and periodic disclosures electronically
- financial products with investment options
- the calculation of the proportion of sustainable investments of financial products
To review these adjustments in more detail please be referred to the consultation.
Introduction
The Sustainable Finance Disclosure Regulation (Regulation 2019/2088, ‘SFDR’) and the Taxonomy Regulation (Regulation 2020/852) were introduced by the European Commission as core parts of the ‘Sustainable Finance Action Plan’. These regulations aim to (i) improve transparency in the market for sustainable investment products and (ii) prevent greenwashing.
The main provisions of the SFDR became applicable on 10 March 2021. Containing more precise disclosure standards, the SFDR Delegated Regulation (Delegated Regulation 2022/1288) was adopted on 6 April 2022 and became fully applicable on 1 January 2023 (except for the first Principal Adverse Impact (‘PAI’) statements, which are due no later than 30 June 2023).
Although the SFDR Delegated Regulation recently entered into force, the European Commission has already mandated the European Supervisory Authorities (‘ESAs’) to review and revise the rules laid down in the SFDR Delegated Regulation. Therefore, the ESAs have launched a consultation with the aim to review the SFDR Delegated Regulation. This consultation is particularly relevant for financial institutions which offer financial products with an investment component to end investors, such as credit institutions, alternative investment fund managers and investment firms. The deadline for comments is 4 July 2023.
In this contribution, we will summarise the most relevant topics of the consultation:
- PAI framework
- The ‘do not significantly harm-principle’
- Decarbonisation
- Simplification and other adjustments
PAI framework
Extension of the list of social indicators
The ESAs proposed a set of four new mandatory and six opt-in social indicators for financial market participants to determine their principal adverse impact. The new mandatory indicators are:
- amount of accumulated earnings in non-cooperative tax jurisdictions
- exposure to companies involved in the cultivation and production of tobacco
- interference in the formation of trade unions or election of worker representatives
- share of employees earning less than the adequate wage
The opt-in indicators relate to use of non-guaranteed-hour employees, temporary contract employees and non-employee workers, insufficient employment of persons with disabilities, and lack of complaint mechanisms.
Technical revision
The ESAs have proposed new formulas and clarifications to definitions and concepts for some of the PAI indicators to achieve greater clarity.
The ‘do not significantly harm-principle’
Under the SFDR, a sustainable investment may not significantly harm any environmental, social or governance objective. However, the SFDR leaves room to financial market participants to determine the requirements an investment must meet to be considered sustainable investment and how they disclose it. As these requirements can be applied differently, it undermines the comparability of the financial products and their underlying investments for investors. This could potentially lead to greenwashing.
Therefore, the ESAs seek input on several alternatives in the consultation: keeping the provisions in the SFDR Delegated Regulation unchanged, providing more specific disclosures and introducing an optional safe harbour for environmental do not significantly harm of Taxonomy-aligned activities.
Decarbonisation targets
Disclosure framework
As many financial products already focus on decarbonisation and the financial institutions offering these products have made net-zero commitments, an increase in financial products relating to decarbonisation and climate change are anticipated. The ESAs are required to propose amendments to the information provided on decarbonisation (i.e., greenhouse gas emissions reduction targets) of financial products in pre‑contractual documents, on websites, and in periodic reports.
In this context, the ESAs propose a different disclosure structure:
- Pre-contractual documents should provide simplified disclosures on the type of outcome the product is committing to achieve and the level of ambition of the target(s)
- Periodic reports should provide additional simplified disclosures on progress to date, explain how the investment strategy contributed to such progress, and identify potential delays in achieving the target(s) and potential adjustments needed
- More detailed disclosures should be available on the website and complement pre-contractual and periodic disclosures. Cross-references to the website should be included in both the pre-contractual documents and the periodic reports
How is the target achieved?
The proposed changes in the consultation include clarifications on the nature of commitments made by financial market participants in their decarbonisation efforts. The objective is that financial products deliver what investors expect and that investors understand clearly what the investment strategy can help achieve. Therefore, the financial market participants would be required to indicate whether they achieve their target of decarbonisation by either divesting and reallocating assets or by investing in assets that deliver decarbonisation over the duration of the investment.
Carbon credits
The ESAs (and recently the Dutch Authority for Financial Markets (Autoriteit Financiële Markten)) question the use of carbon credits in the net-zero mission. The use of carbon credits can give rise to greenwashing concerns. The aim of the commitment to net zero under the Paris Agreement is to reduce emissions as much as possible and to use offsets only for residual hard-to-abate emissions. Because offsetting capacity is scarce, credits should not be used for avoidable emission.
In this context, the ESAs states that the use of greenhouse gas removal techniques and carbon credits should not be considered and disclosed to investors as means to achieve reduction of greenhouse gas emission. Therefore, the ESAs suggest that financial market participants report separately on their investments’ greenhouse gas emission, greenhouse gas removal and use of carbon credits. In addition, if the financial market participant directly finances greenhouse gas mitigation projects (by using carbon credits), it is proposed to separately disclose the use thereof as well.
Simplification and other adjustments
The annexes of the SFDR Delegated Regulation include several financial product disclosure templates. These templates have been criticised for their excessive length and complexity. Therefore, the ESAs also want to consult several simplifications of these templates.
Furthermore, the ESAs aim to address several technical issues relating to, among other things:
- the treatment of derivatives
- the presentation of information
- delivery of pre-contractual and periodic disclosures electronically
- financial products with investment options
- the calculation of the proportion of sustainable investments of financial products
To review these adjustments in more detail please be referred to the consultation.