Dechert LLP

On 4 February 2021,1 less than six weeks before the 10 March 2021 date on which the main operative provisions of the Sustainable Finance Disclosure Regulation (SFDR)2 start to apply, the European Supervisory Authorities (ESAs) published their final report on the draft level 2 regulatory technical standards (the Revised RTS) for the SFDR. In April 2020, the ESAs published draft regulatory technical standards3 (the April 2020 RTS) and launched a consultation on their content. The ESAs noted in the Revised RTS that they had received significant feedback from stakeholders on the April 2020 RTS. In this ESG Legal Update we highlight some of the key points of the Revised RTS as well as looking at some of the differences between the April 2020 RTS and the final draft Revised RTS.

It is important to note that the ESAs have recommended that the final Revised RTS take effect on 1 January 2022, and consequently our understanding is that there is no need for financial market participants (FMPs) to comply with the detailed provisions of the Revised RTS from 10 March 2021.4

However, FMPs must continue their preparations to comply with the provisions of the level 1 text of the SFDR from 10 March 2021.

A brief recap

The SFDR required the ESAs to prepare regulatory technical standards to provide further detail on, and to assist in, the application of the SFDR provisions (RTS). The SFDR states that six of the RTS must be delivered to the EU Commission by 30 December 2020 and one must be delivered by 30 December 2021. Notwithstanding the deadline of 30 December 2020, the ESAs published the Revised RTS on 4 February 2021, after they had requested that the EU Commission delay the application of the RTS.

Shortly before the publication of the Revised RTS, the ESAs wrote a letter5 to the EU Commission on 7 January 2021 asking for urgent clarification on a number of points in the SFDR (the ESAs’ Letter). The questions fall outside of the scope of the RTS and are not addressed in the Revised RTS. The EU Commission is expected to respond to the ESAs’ Letter, but there is no indication as to when that response may be forthcoming.

In addition to highlighting areas of concern with the SFDR level 1 text in the ESAs’ Letter, the tone of the Revised RTS further emphasises the ESAs’ dissatisfaction with the SFDR and their remit to provide RTS. For example, when speaking of their mandate to “design a single set of uniform pre-contractual disclosures for very different types of documents which serve different purposes”, the ESAs expressly state their belief “that this is a sub-optimal situation leaving the disclosures unfit for purpose for both types of documents.”

Highlights of the Revised RTS

1. FMPs do not have to comply with the provision of the Revised RTS from 10 March 2021

The ESAs propose that the date of application of the Revised RTS is 1 January 2022. FMPs must continue to prepare for the SFDR go live on 10 March 2021 but do not need to focus on the details of the Revised RTS.

While this is useful in that FMPs will not need to undertake wholesale changes by 10 March 2021, FMPs will need to review and update their disclosures and build systems and procedures in preparation for complying with the Revised RTS from 1 January 2022. Notwithstanding the fact that the Revised RTS will not apply from 10 March 2021, if FMPs have decided to voluntarily comply with certain elements of the SFDR, for example the requirement to provide a ‘principal adverse impacts statement’ under Article 4 of the SFDR from 10 March 2021, they should consider the content of the Revised RTS in order to better understand what they are committing to on an on-going basis.

2. Principal Adverse Sustainability Impacts Statement Table 1 of Annex I

a. The number of adverse sustainability indicators included in Table 1 of Annex I has been significantly reduced

The April 2020 RTS included 32 mandatory indicators related to the principal adverse impacts of sustainability factors, as well as 18 additional indicators. The number of mandatory indicators in the Revised RTS has been reduced to 14, with a requirement to include at least one additional indicator related to principal adverse impacts on a climate or other environment related sustainability factor6 and at least one additional indicator related to principal adverse impacts on a social, employee, human rights, anti-corruption or anti-bribery sustainability factor.7

Many of the mandatory original indicators in the April 2020 RTS are now classed as ‘additional’ indicators in the Revised RTS.

The ESAs have also provided separate mandatory indicators for investments in sovereigns (and supranationals) and real estate assets, that are in addition to the 14 indicators. For investments in sovereigns (and supranationals), the ESAs have included one further mandatory climate and environmental indicator on greenhouse gas emission intensity and one further mandatory social indicator relating to investment in countries subject to social violations. For investments in real estate assets, the ESAs have included two further mandatory climate and environmental indicators relating to exposure to fossil fuels through real estate assets and exposure to energy-inefficient real estate assets.

b. New ‘actions taken’ disclosure requirement incorporated into Table 1 of Annex I

The ESAs have integrated a new ‘actions taken’ disclosure requirement into Table 1 of Annex I, together with the principal adverse impact indicators. FMPs are required to provide a description of the actions taken during the reference period and actions planned or targets set by the FMP for the next reference period in order to avoid or reduce the principal adverse impacts identified.

When describing (i) the adverse impacts of investment decisions of the FMP on sustainability factors and (ii) the actions taken during the reference period and actions planned or targets set by the FMP for the next reference period, the RTS require that the assessment is based on at least the average of four calculations made by the FMP on 31 March, 30 June, 30 September and 31 December during the reference period.8

3. Translation requirement for Principal Adverse Sustainability Impacts Statement ‘Summary’ section and Website Product Disclosure ‘Summary’ section

One novel, and unexpected, requirement is for FMPs to translate the summary section of the principal adverse sustainability impacts statement required under Article 4 of the SFDR and also the summary section of the website disclosure pursuant to Article 10 of the SFDR provided in relation to light green (Article 8 SFDR) and dark green (Article 9 SFDR) financial products.9

Specifically, the summary statement must be provided in “one of the official languages of the home Member State of the financial market participant and, where different, in an additional language customary in the sphere of international finance; and [(b)] where a financial product of the financial market participant is marketed in a host Member State, one of the official languages of that host Member State”.10

Although the requirement only attaches to the summary section, this is still an onerous obligation.

4. Template pre-contractual disclosure for Article 8 and Article 9 financial products – an ESG KID?

The Revised RTS set out the details of the content and presentation of the pre-contractual disclosures.

FMPs are required to provide the ESG specific pre-contractual disclosure information in a separate annex and in the template format prescribed in the Revised RTS.11 In addition, FMPs are required to include in the main body of the pre-contractual disclosure document a prominent statement that information related to environmental or social characteristics (for Article 8 SFDR financial products) or sustainable investment (for Article 9 SFDR financial products) is available in that annex. For example, UCITS funds will need to include a statement with their other pre-contractual documentation, such as the fund prospectus, notifying investors that the SFDR disclosures are available in a separate annex to the main body of the prospectus.

The ESAs identified already in the consultation paper to the April 2020 RTS that it would be challenging to prepare a single set of regulatory technical standards at pre-contractual level that would work equally well for the different types of pre-contractual disclosure documents listed under Article 6(3) of the SFDR (from UCITS prospectuses for retail clients to managed account agreements with institutional clients), and the provisions in the Revised RTS are, as the ESAs themselves say, ‘sub-optimal’.

Effectively, FMPs are being required to provide a type of ESG key information document for Article 8 and Article 9 financial products. One must question whether this document is of any benefit to retail investors or of any use to institutional investors.

5. Reduction in the number of ‘top investments’ included in periodic reports

The number of ‘top investments’12 to be included in the periodic report that the FMP prepares under Article 11 of the SFDR has been reduced. The April 2020 RTS required FMPs to provide information on the ‘top 25 investments’ of the financial product in the periodic reports, but in the Revised RTS the number of ‘top investments’ has been reduced to the ‘top 15 investments’.

6. Historical year-by-year comparison

The April 2020 RTS proposed that FMPs look back over 10 previous reference periods. This look back has been halved, and FMPs are only required to provide a historical year-by-year comparison with previous reference periods, for at least the five previous reference periods.

This historic comparison applies to both the periodic reports13 that the FMP prepares under Article 11 of the SFDR and also where the FMP has provided a description of adverse impacts on sustainability factors for a previous reference period under Article 4 of the SFDR. In the latter case that descriptive statement needs to contain a historical comparison of the current reference period with the previous reference period provided and include further historical comparisons within that statement for at least the five previous reference periods.14

7. ‘Light touch’ references to environmental or social characteristics do not excuse FMPs from complying with Article 8 obligations.

The Revised RTS include a new Recital (22) which says that where a financial product includes language that promotes environmental or social characteristics in documents the “financial product should include the pre-contractual and periodic disclosures set out in this Regulation”. The drafting of the provision is somewhat confusing but the point being made appears to be that if an FMP refers for example, to a ‘green strategy’ in its marketing materials or if the financial product is labelled as an ‘Environmentally Sustainable Fund’, or other documents imply that the particular financial product has an environmental or social characteristic, the expectation is that the FMP should be making the disclosures associated with an Article 8 financial product.

8. Look-through principle

The Revised RTS include specific provisions where the investee company is a holding company, collective investment undertaking or special purpose vehicle. In such circumstances, FMPs that have sufficient information on the adverse impacts of the investment decisions of those companies should look through to the individual underlying investments of those companies and consider the total adverse impacts arising from them.15

What is an unwelcome addition is that where those FMPs do not have such information on the individual underlying investments of those companies, FMPs are not considered to take into account the principal adverse impacts of their investment decisions on sustainability factors.

9. Other points to note
  • While products that have sustainable investment as an objective (Article 9 financial products) are expected to make only sustainable investments, the Revised RTS provides16 that it is nonetheless appropriate to require disclosures on the amount and purpose of any remaining investments to demonstrate how those investments do not prevent the financial product from attaining its sustainable investment objective. The implication being that not all investments in an Article 9 financial product must qualify as ‘sustainable investments’ although they will still need to comply with the ‘do no significant harm’ principle.
  • The Revised RTS clarify that where an investment exclusively finances a project or type of project, such as an investment in a green bond, social bond or project bond, the assessment of the adverse impacts of the investment decisions should be limited to the adverse impacts of the targeted project or type of project. There is no requirement to look to the issuer of the bond.17
  • The Revised RTS permit exclusion strategies but highlight that end investors must be provided with the necessary information to assess the materiality of the criteria of the exclusion strategy on investment decisions, and the impact of that strategy on the composition of the resulting portfolio. The Revised RTS highlight that showcasing the exclusion strategy must not be a form of ‘greenwashing’.18
10. Key questions remain unanswered

The Revised RTS do provide some clarity but many questions remain unanswered and many points are still unclear. The EU Commission’s response to the ESAs’ Letter will hopefully provide some guidance on the specific points raised, (such as “What is the meaning of ‘promotion’ in the context of products ‘promoting’ environmental or social characteristics?”), but additional information in the form of an SFDR ‘Questions and Answers’ paper would be welcome.

What next?

The EU Commission is expected to endorse the Revised RTS within three months of their publication.

In June 2020, the EU Commission published draft delegated legislation that proposed integration of sustainability into the frameworks of the UCITS Directive, AIFMD and MiFID II. It is anticipated that these delegated acts will be published later in 2021 and will apply 12 months after they enter into force.

Conclusion

The timing of publication of the Revised RTS is perhaps not ideal, but there is comfort in the fact that they will not apply until 1 January 2022, meaning FMPs can focus on compliance with the level 1 text of SFDR from 10 March 2021.

Many questions remain unanswered and although the Revised RTS address some of the concerns raised by stakeholders – fewer mandatory indicators, shorter look back periods, fewer top investments – there have been some unwelcome additions – such as the translation requirement, the obligation to look through to the individual underlying investments of investment funds and consider the total adverse impacts arising from them – and, although reduced, FMPs still need to report on 14 mandatory indicators in the principle adverse impacts statement. The result being that FMPs will be subject to detailed, onerous, and often unclear obligations.

 

Footnotes

1) Although the Revised RTS are dated 2 February 2021, they were not actually published until 4 February 2021.

2) Regulation (EU) 2019/2088 on sustainability-related disclosures in the financial services sector (SFDR), as amended by Regulation (EU) 2020/852 on the establishment of a framework to facilitate sustainable investment (Taxonomy Regulation).

3) For more information on the April 2020 RTS, please see our OnPoint “ESAs’ Consultation on the Draft Regulatory Technical Standards of the Sustainable Finance Disclosure Regulation”, available here.

4) The EU Commission confirmed in October 2020 by way of a letter to the ESAs, that compliance from 10 March 2021 was on a principle-based approach. The EU Commission confirmed that the RTS would not apply on 10 March 2021 but would apply “at a later stage”. To view the EU Commission’s letter, please click here.

5) To access the letter from the ESAs, please click here. For more information on the ESAs’ letter, please see our OnPoint “Preparing for SFDR”, available here.

6) As set out in Table 2 of Annex I.

7) As set out in Table 3 of Annex I.

8) See Article 6(3) of the Revised RTS.

9) See Articles 5(2) and 33(2) of the Revised RTS.

10) See Articles 5(2) and 33(2) of the Revised RTS.

11) See Articles 13 and 20 of the Revised RTS.

12) ‘Top investments’ should be calculated as the investments accounting for the greatest proportion of investments over the course of the reference period, calculated at appropriate intervals to be representative of that reference period. See Articles 60 and 66 of the Revised RTS.

13) See Article 71(1) of the Revised RTS.

14) See Article 6(4) of the Revised RTS.

15) See Recital 4 of the Revised RTS.

16) See Recital 23 of the Revised RTS.

17) See Recital 5 of the Revised RTS.

18) Recital 25 of the Revised RTS describes ‘greenwashing’ as the practice of gaining an unfair competitive advantage by recommending a financial product as environmentally friendly or sustainable, when in fact that financial product does not meet basic environmental or other sustainability-related standards.

×