ESAs propose adjustments to the EU SFDR rules

On 12 April 2023, the European Banking Authority, European Securities and Markets Authority and European Insurance and Occupational Pensions Authority (the ESAs) published a joint consultation paper on a review of the Sustainable Finance Disclosure Regulation (SFDR) Delegated Regulation ((EU) 2022/1288 dated 6 April 2022), the Level 2 regulatory technical standards (RTS). 

This comes in response to the European Commission’s April 2022 letter asking the ESAs to review and propose amendments to the RTS. The areas on which the ESAs are consulting go beyond that explicit mandate, in order to address technical issues that have emerged since SFDR came into force in March 2021 and to broaden the disclosure framework. The proposed amendments relate to the detail of the SFDR and EU taxonomy-aligned disclosures and are significant, in particular for firms that consider principal adverse impacts (PAI) on sustainability factors and whose products are promoting E or S characteristics (Article 8), are making some sustainable investments (Article 8+), or those which have a sustainable investment objective (Article 9). The deadline for responses is 4 July 2023.

The consultation acknowledges that whilst, in the case of some areas under scrutiny (in particular the specific “do no significant harm” (DNSH) disclosures), the status quo would avoid market disruption and further significant implementation efforts, it would also preserve already-identified weaknesses of the current framework and leave the risks of greenwashing and insufficiently rigorous disclosures unaddressed, likely for several more years. Therefore change is being proposed. 

We have set out below a summary overview of some of the proposed changes being consulted on.

• Extending the list of social indicators for the disclosure of PAI. This includes additional mandatory (e.g., amount of accumulated earnings in non-cooperative tax jurisdictions and share of employees earning less than the adequate wage) and optional PAI indicators (e.g., excessive use of temporary contract employees in investee companies and insufficient employment of persons with disabilities within the workforce) for social issues, as well as revisions to the presentation and calculation of some existing indicators. 
• Currently there is no social PAI indicator for real estate investments, and the ESAs propose that for this asset class these indicators could apply to the entity managing the asset (either the financial market participant or another entity that is doing the management).
• Refining the content of a number of other indicators for adverse impacts and their respective definitions, applicable methodologies, metrics, and presentation. For example, a proposal to expand and align with EU taxonomy screening criteria the definition of “inefficient real estate assets” for the purposes of the PAI mandatory indicators for real estate asset investments; a building constructed before 31 December, 2020 would fall within this definition if it has an Energy Performance Certificate (EPC) below C and (broadly) is not within the top 30% of national or regional building stock. This raises the current reporting challenge of a lack of standardization for EPC ratings as well as for non-EU products and assets where EPC ratings are not used.
• Amendments relating to decarbonisation (or greenhouse-gas emissions reduction) targets, including template disclosures on decarbonisation targets and the share of investments that the target covers.
• More specific disclosure requirements regarding DNSH under PAI for sustainable investments, in order to increase transparency and support some degree of comparability. This includes a firm publishing quantitative thresholds for the use of PAI indicators to determine that their sustainable investments “do no significant harm” to any E or S objectives, which are part of the website disclosure of that product. The consultation notes that there is still a risk that the DNSH test is applied by firms to allow investments in what some may consider significantly harmful activities.
• Simplifying the Article 8 and 9 templates for pre-contractual and periodic disclosures, in particular to make the format and language more understandable for consumers and retail investors. The proposed new template disclosures have a new dashboard of key information at the top, to identify whether the product has a sustainable investment objective or promotes E or S characteristic as well as to identify the minimum commitments of (i) investments used to meet the E/S characteristics or sustainable investment objectives; minimum figure of (ii) sustainable investments; and (iii) investments aligned with the EU taxonomy. This potentially removes the need for the asset allocation illustrative diagram on the existing template.
• Making other technical adjustments concerning, among others, the treatment of derivatives and the definition of equivalent information and provisions for financial products (such as insurance-based investment and pension products) with underlying investment options.

The European Commission is expected to undertake a comprehensive assessment of SFDR, due to commence in Q3/Q4 2023. This could mean wholesale changes to SFDR, involving the introduction of a labeling mechanism and/or more precise definitions of the product categorisations. However, this does not mean that the proposals set out in the consultation paper can be sidelined. We would expect the final Delegated Regulation currently under review to come into force in the next six months or so and before there is significant movement on the Commission’s anticipated overhaul. 

To discuss the contents of this alert, please contact the authors or your usual Goodwin contact.