EU Sustainable Finance Disclosure Regulation: Another Step Towards An ESG-Driven Economy

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[co-author: Grace Oyegbile]

On March 10, 2021, a host of provisions came into effect as part of the European Union’s (“EU”) Regulation on Sustainability‐Related Disclosures in the Financial Services Sector (the “Sustainable Finance Disclosure Regulation” or “SFDR”). The SFDR requires certain financial service institutions, most notably those managing or marketing investment or pension funds/products in the EU, to disclose on various sustainability considerations to both potential investors and the general public. These disclosure requirements are, in general, aimed at increasing the incorporation of sustainability matters into regulated entities’ decision-making, thereby furthering marketplace considerations towards an “impact economy.”

Current Requirements of the SFDR

Many of the obligations imposed by the SFDR are not limited to companies offering products that are marketed as “sustainable”; rather they apply to regulated financial service institutions across the market (with certain, limited distinctions between financial market participants (“FMPs”) and financial advisers). All regulated financial service institutions are expected to disclose their policies for integrating sustainability risk and consideration of principal adverse sustainability impacts into their decision-making/advice. However, FMPs are subject to further obligations, and the specific scope of these obligations differs between FMPs and financial advisers, as described below:

Financial Market Participants

The SFDR requires FMPs to disclose various information on their websites, including:

  1. Policies for integrating sustainability risk into their investment decision-making;
  2. A statement on their due diligence policies for consideration of principal adverse sustainability impacts of their investment decisions or, for FMPs with 500 or fewer employees that do not consider such impacts, a statement explaining why such impacts are not considered and whether/when they intend to consider them; and
  3. Information on how remuneration policies are consistent with the integration of sustainability risks.

FMPs are also required to provide pre-contractual disclosures on how sustainability risks are integrated into their investment decisions and to carry out and provide the results of an assessment of likely impacts of such risks on the returns of the financial products they offer (or an explanation of why such risks were deemed irrelevant). Financial products that either promote environmental/social characteristics or that have sustainable investment as their objective must also disclose information on how those characteristics/objectives are measured and met. This additional information is to be included not only in website-hosted and pre-contractual disclosures, but also in disclosures in the FMP’s periodic reports.

Financial Advisers

The obligations imposed on financial advisers are less onerous. In general, such advisers are expected to provide information on:

  • Policies for integrating sustainability risk into their investment advice (website);
  • Whether they consider principal adverse sustainability impacts in their advice, or an explanation of why not and whether/when they intend to consider such impacts (website); and
  • How sustainability risks are integrated into their advice and the results of an assessment of the likely impacts of such risks on the returns of the financial products they advise on (or an explanation of why such risks were deemed irrelevant) (pre-contractual).

Outstanding SFDR Requirements

Further SFDR requirements have yet to come into effect. For example, the SFDR is also set to require FMPs to provide product-level statements on the consideration of principal adverse sustainability impacts by year-end 2022. Additionally, to flesh out certain of the high-level descriptions in the SFDR, the European Supervisory Authorities (“ESAs”) — i.e., the European Securities and Markets Authority, the European Banking Authority and the European Insurance and Occupational Pensions Authority — are required to publish more detailed requirements in Regulatory Technical Standards (“RTS”). The ESAs submitted their final report on the draft RTS in February 2021, and compliance with the RTS is expected to become mandatory following endorsement by the European Commission. The ESAs have proposed that the requirements of the RTS should apply from January 1, 2022 (but the final date of implementation is still to be set by the European Commission).

Importantly, the RTS establishes a set of 14 key environmental and social indicators that FMPs are required to report on as part of their statement on principal adverse sustainability impacts. FMPs are also required to report on one additional environmental and one additional social factor beyond the 14 mandatory indicators, and a reporting template is provided in the annex to the RTS. The RTS also requires a qualitative discussion of sustainability impacts. This must include information on various policies, as well as a description of adherence to various internationally recognized due diligence and reporting standards for both environmental and social matters.

Although the RTS is not currently binding, the ESAs have recommended that the draft RTS be treated as guidance for the preparation of reports in the interim.

Implications

Ultimately, while technically a disclosure framework, the SFDR is intended to spur behavioral change. The EU continues to fortify its sustainability regulations, particularly with regards to the financial sector. Although the SFDR only directly affects financial service institutions, those institutions will have to obtain environmental, social and governance (“ESG”) information from the companies they invest in to comply with their own obligations.

We can therefore expect that financial service institutions based, or offering products, in the EU will begin to require more ESG- and sustainability-related information from companies they invest in. In our prior analysis of the impacts of the Final Recommendations of the Task Force on Climate-related Financial Disclosures, we noted that financial institutions are increasingly requesting more detailed sustainability information from their clients. The requirements of the SFDR will only accelerate that trend.

Companies should consider how their own activities, and awareness of their own ESG profile, will align with the reporting obligations of their investors. To the extent possible, companies should at least assess their current and foreseeable capital requirements and understand how their existing capital providers may incorporate sustainability into their investment appetite going forward. However, we expect that companies that anticipate and respond to the increasing ESG information needs of financial institutions will be better situated to access, or maintain access to, capital in the future. To that end, companies should consider assessing their own sustainability impacts and their alignment with the major ESG standards and benchmarks applicable to their operations.

But companies do not have to undertake this assessment alone.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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