European Supervisory Agency Joint Consultation on ESG disclosures

Background

Regulation 2019/2088 on sustainability-related financial disclosures (“SFDR”) was adopted on 27 November 2019 with the objective to improve transparency in relation to ESG factors, risks and impacts. It is applicable notably to fund managers (“entities”) and investment funds (“products”).  On 23 April 2020, the European Supervisory Agencies (“ESAs”) launched a consultation with respect to draft regulatory technical standards (“draft RTS”) discussing:

• the disclosure of principal adverse impacts (“PAIs”) of investment decisions, required for all entities:
  • which are employing 500 persons or are the parent company of a group employing 500 persons on a consolidated basis from 18 months after the date of entry into force of SFDR
  • other entities which do not publish a clear explanation why they do not consider PAIs
• precontractual, website and periodic disclosures required at product level for both:
  • products with environmental or social characteristics among other characteristics (“light green products”)
  • products with a sustainable investment objective (“dark green products”)

Investment fund sponsors and managers need to make strategic business and policy decisions well ahead of any applicable disclosures which will have to comply with SFDR and the final RTS. 

Primary change

The draft RTS provide granular requirements for the content, the methodology and the presentation of disclosures and a template for principal adverse impacts and metrics to be used by entities. While the objective is to improve standardization and comparability of the information provided to investors, the proposed template is likely to bring significant changes to fund managers.

The ESAs also intend to develop templates for precontractual and periodic report disclosures, but they are not included in the draft RTS.

Timeline

The consultation closes on 1 September 2020 and the ESAs must submit all RTS to the Commission by 30 December 2020, except those in relation to sustainability indicators in the field of social and employee matters, respect for human rights, anti-corruption and anti-bribery matters which must be submitted by 30 December 2021. Most disclosure requirements will apply from 10 March 2021.

However, funds’ periodic report disclosures will start applying in respect of  financial years commencing  1 January 2022. Disclosure of principal adverse impacts in funds’ offering documents and periodic reports will become applicable as from 30 December 2022.

Key Points

• Principal Adverse Impacts

Context, scope and implications:

The overall objective of the RTS is to ensure that the entities disclose relevant information regarding their adherence to the “do not significantly harm” principle where their financial products invest in sustainable investments. The objective is to inform end-investors about how the product does not significantly harm the environmental objectives it is not contributing to. The ESAs are of the view that this should be facilitated for those entities which consider the PAIs of their investment decisions since they will already have incurred the costs of assessing their investment decisions against the indicators provided in the annex 1 of the RTS.

According to the upcoming Taxonomy Regulation art. 19(1)e, the technical screening criteria developed by the Technical Expert Group to assess under which conditions an economic activity contributes to a sustainable environmental objective should, where feasible, use these sustainability indicators to assess PAIs from these RTS.

Information on PAIs is required to be disclosed first on the entities websites as from 10 March 2021. Any entities that employ less than 500 persons or that are parent undertakings of a group employing less than 500 persons on a consolidated basis during the financial year may opt not to consider PAIs. If they decide to not consider PAIs, they will still need to make a clear statement about this decision, explain the reasons and  whether and when they intend to comply. Consideration of PAIs is compulsory for large entities which must disclose on their website the statement in the format prescribed by ESMA.

Disclosures of PAI will also be required in offering documents and periodic statements as from 30 December 2022. Where information in periodic reports  includes quantifications of principal adverse impacts on sustainability factors, that information may also rely on the provisions of these regulatory technical standards [1].

Elements of disclosure

Annex 1 provides a PAI statement template structured in three parts including adverse sustainability indicators and associated metrics. One table provides 16 mandatory environmental indicators and 16 mandatory social indicators. Two tables provide 11 additional environmental indicators and 7 additional social indicators. Entities must disclose metrics for all mandatory indicators, at least one additional environmental indicator and one additional social indicator as well as any other PAI deemed to be relevant.

The content is proposed to be structured as follows:

• Disclosures applicable to light green and dark green products

General framework and interaction with the upcoming Taxonomy Regulation

The draft RTS provide a comprehensive list of information and sections to be included for precontractual documentation, website information and periodic report for both dark green and light green products. Most disclosure items are common to each support or closely related: logically, pre-contractual information focuses on the description of product features, the definition of investment strategy indicators and the means used to attain the investment objective. Website information provides more information on the data used, the methodological aspects and policies. Periodic reports focus on metrics and sustainability performance measures.

At present, it must be noted that the definition of sustainable investments in SFDR includes both environmental and social objectives while the draft taxonomy is only limited to environmental objectives. Article 25 of the draft taxonomy constitutes an occasion for the ESAs, through the RTS they are empowered to develop, to strengthen the link between sustainable investments as defined under SFDR and investments financing taxonomy-compliant activities but there is no full correspondence between both yet, hence the proposed requirement to disclose proportion of investments in taxonomy-compliant activities.

Elements of disclosure

Light green color requirements apply only to light green products and dark green color requirements apply only to dark green products. Other requirements are substantially the same for both types of product.

Practical considerations

Investment fund managers (“IFMs) should carefully consider  the final RTS but also review, decide and formalise whether and to what extent they have to or wish to comply with the disclosure principal adverse impacts of their investment decisions. Factors to consider include, inter alia:

• whether the funds managed by the IFM qualify as light green, dark green or other funds
• the greater transparency arising from other mandatory requirements applicable to all IFMs such as the establishment of a policy on the integration of sustainability risks in the investment decision-making process and the consistency of such policy with the remuneration policy 

Where they comply with the disclosure of PAIs, a comprehensive action plan should be launched to create or update the policies, the procedures, the data flows, the methodologies, the systems and disclosures which have to be implemented both at entity and product level. Should they decide not to disclose PAIs, IFMs will still need to review their documentation to ensure that the mandatory SFDR requirements which are not covered by these draft RTS are met.

Fund managers should notably:

• determine whether the products they manage qualify as a light green or dark green product
• assess how the product promotes E/S characteristics or contributes to a sustainable investment objective
• establish the list of the sustainability indicators to be used, the data sources, and the methodologies (including the use of benchmarks) for monitoring and reporting purposes
• prepare disclosures and ensure their consistency with any marketing material