6 November 2023

EU ESG disclosure update

A) EU sustainable finance disclosure latest

1. SFDR Level 1 review: latest views expressed

“I’m personally very much in favour of having some kind of labels for retail investors.” Verena Ross – Chair, European Securities and Markets Authority

“A classification regime building on article six, eight and nine, with some clear minimum standards and criteria, would be a really welcome addition.” Patricia Dunne – Director, Central Bank of Ireland

“AFM proposes the introduction of ‘transition’, ‘sustainability’, and ‘sustainability impact’ labels.” Position paper on improving the SFDR – Autoriteit Financiële Markten, Netherlands.

As a general reminder, the aim of the European Commission’s current Level 1 SFDR consultation is to enable their understanding of “any potential shortcomings”, while “exploring options to improve the framework”.

The detailed questionnaire summarises four ‘main topics’ grouped by the EC:

Current requirements of the SFDR [p.4-14];
Interaction with other sustainable finance legislation [p.15-18];
Potential changes to disclosure requirements for financial market participants (FMPs) [p.19-29];
Potential establishment of a categorisation system for financial products [p.30-44].

The EC’s proposed ‘sustainable’ fund labelling scheme has won the recent backing of many EU supervisory bodies:

European Securities and Markets Authority: speaking at the EC’s SFDR webinar on 10 October, the ESMA chair suggested funds are either categorised per investment strategy (e.g. ‘climate transition’, ‘impact investing’), or graded per sustainability level (akin to EU building Energy Performance Certificates);
Central Bank of Ireland: addressing the same event, a CBI director said current SFDR product categories are already a de-facto fund labelling scheme, which now require “clear minimum standards and criteria”;
Autoriteit Financiële Markten: in their new SFDR position paper, the Dutch regulator advocate sustainable product labels “…that investors can understand, such as ‘transition’, ‘sustainable’ and ‘sustainable impact’, to ensure alignment with investor expectations and objectives as well as the actual sustainability profiles of investment products”.

The EC’s key suggestion that all financial products could be subject to the same basic level of ‘sustainability’ disclosure is also attracting support from EU regulators.

The European Commission (EC) Level 1 SFDR consultation continues until 15 December 2023.

However, given the pending EU election process, it is unlikely legislative proposals will be presented to the new Commission until late-2024 (at the earliest).

NB: a replay of the recent ‘Sustainability Finance Disclosure Regulation – what next?’ EC event is now available.

2. SFDR ‘1.5’: updated RTS still to appear

Fund firms still wait for an update on the European Supervisory Authorities (ESAs) latest set of draft Level 2 SFDR/TR technical specifications, following the consultation process that ended in July.

It is currently expected the EC may receive a revised RTS version later this month (based on interim respondent feedback). If approved, a finalised Delegated Act may be published in the EU Official Journal (EUOJ) circa end Q4-2023 / early Q1-2024 (i.e. entering into force within 20 days later).

As before, given the high impact of the changes proposed within the ESA’s 158-page document, it is assumed the remainder of 2024 will be made available as a transition period, enabling FMPs to upgrade their Entity and Product disclosure information (e.g. precontractual documents, periodic reports and websites), where necessary.

3. ESAs, ESMA outline Sustainable Finance activities next year

As mentioned in the latest non-ESG catch-up, the European Supervisory Authorities confirmed their respective Sustainable Finance activity areas next year.

a) ESA joint work programme 2024

The ESA Joint Committee (comprising ESMA, EIOPA and the EBA) have outlined their cross-sector 2024 workplan.

This includes SFDR-related output (p.4), lined-up for delivery next year:

Q&As and “other Level 3 tools”: more advice on the practical application of SFDR rules (i.e. “especially” the ESA’s evolving disclosure specifications);
Assessment of marketing communications: part of ESA ‘supervisory convergence tools’ to prevent greenwashing, this may include another draft SFDR specification, covering ‘standardised’ marketing communication presentation;
Annual report on principal adverse impact (PAI) indicators: for the first time, based on information now made available from compulsory SFDR disclosure templates;
Ad-hoc SFDR Level 1 review contributions: where requested by the EC, meantime.

b) ESMA 2024 annual workplan

In parallel, ESMA’s latest annual planning includes their individual SFDR-related activities in 2024, including:

A ‘final greenwashing report’ delivered to the EC: proposing actions taken to be taken;
Delivery of other ‘Sustainable Finance Roadmap’ priorities: published by ESMA last year;
Support of the new ‘transition finance’ framework: announced by the EC this year.

NB: in relation to investment management (p.20-21), ESMA also mention the EC’s current level 1 reviews of both the PRIIPs Regulation and SFDR “may give rise to additional single rulebook work within the Joint Committee”.

B) other EU sustainability updates

1. ESMA ESG Fund Naming rules: latest

“There are fund names that excessively sell certain sustainability features, when the underlying portfolio doesn’t necessarily match this. That’s what prompted out action to make sure investor protection is preserved in this space.”

Antonio Barattelli – European Securities and Markets Authority

One year ago, ESMA launched a consultation on ESG / sustainability-related terms in fund names.

To curb ‘greenwashing’ and ensure marketing communications are ‘clear, fair and not misleading’, draft guidelines included quantitative thresholds linked to the use of sustainability-related terminology in funds’ names:

Fund name including an ESG-related word: at least 80% of investments should be used to meet the ‘environmental or social characteristics’ or ‘sustainable investment objectives’ of the product.
Fund name including a “sustainable” related word: should also allocate at least 50% of investments that meet the SFDR legal definition of ‘sustainable investment’.

There has been no formal ESMA response since their consultation closed in February. The guidance was expected to be finalised during Q2-2023, ahead of formal application within 3 months of publication.

You may recall the draft guidelines were criticised by members of the European Fund and Asset Management Association (EFAMA), who suggested they are put aside until the ambiguous ‘sustainable investment’ definition (i.e. currently under scrutiny in the EC Level 1 consultation) is formally rectified.

However, Responsible Investor recently reported that ESMA intends to “push-ahead” with their guidance to tackle greenwashing, as they continue to review the large amount of industry feedback received and consider the timeline for their next steps. This is despite an EC spokesperson quoted in the same article: “…we do believe, however, that [greenwashing] would be best tackled in the context of a potential review of the SFDR”.

ESMA has also published a report covering ‘ESG names and claims in the EU fund industry’.

Their analysis of 36,000 EU-UCITS products (managing EUR16 trillion of assets) concludes that around 14% of funds currently use in their name terms directly related to environmental, social and governance. They also point to “consistently higher demand” for funds with ESG-related words in their name, compared to other UCITS.

NB: ESMA’s recent webinar presented a summary of their latest findings.

2. ESMA launch MiFID II sustainability Common Supervisory Action

ESMA recently gave notice of another Common Supervisory Action (CSA) in 2024, this time covering the integration of MiFID II ‘sustainability’ in firms’ suitability assessments and product governance frameworks.

Next year, ESMA and EEA-regulators will assess progress made by MiFID II entities in applying their new regime sustainability requirements, legally applied in August 2022 and November 2022. They will examine how firms:

Collect information on their clients’ “sustainability preferences”;
Have put into place arrangements to understand and correctly categorise investment products with sustainability factors for the suitability assessment;
Ensure the suitability of an investment with respect to sustainability;
Specify any sustainability-related objectives a product is compatible with as part of the target market assessment of the investment product.

This supervisory review will take place alongside the current CSA that runs until Q3-2024 to formally assess the compliance of existing SFDR/TR L2 disclosure rules (applicable to UCITS and AIFM firms and products).

NB: another reminder that both MiFID II regime updates were supplemented with respective ESMA guidance on suitability and product governance, which entered into application on 3 October 2023.

We still anticipate FinDatEx will shortly confirm if any changes are required to their European MiFID or ESG templates (EMT, EET) to reflect the revised MiFID II Guidance now in place.

3. EC: publish two new Taxonomy FAQs

On 20 October, two new EC ‘FAQ’ documents covering the Taxonomy Regulation (TR) were published in the EUOJ.

The first EC FAQ: covers issues related to technical screening criteria for economic activities that contribute substantially to climate change mitigation / adaptation and do no significant harm (DNSH)
The second EC FAQ: focuses on disclosure issues related to TR-aligned economic activities and assets

Both of these documents pertain to SFDR disclosures, with FMPs obliged to use both:

Disclosures on Taxonomy-alignment of investee companies for assessing the level of environmental performance of marketed financial products making sustainability claims;
The KPIs disclosed by investee companies for assessing the level of environmental performance of marketed financial products.

NB: the first FAQ above seeks to clarify how the SFDR framework should apply to the defence sector (p.11-12).

4. EU member state SFDR round-up

Recent developments of note include:

Luxembourg: CSSF SFDR data collection

The deadline for the initial Pre-contractual disclosure exercise has now passed. The separate Periodic Report exercise continues until 31 January 2024 (with an eDesk solution made available later this month).

Ireland – CBI uncover SFDR “misuse”

The local regulator reveals instances of SFDR ‘article 8’ funds disclosing “low or even zero” AUM proportions aligned with environmental or social characteristics.

Netherlands – AFM warn against SFDR marketing

The AFM’s recent Guidelines on Sustainability Claims state the use of SFDR classifications as a means of promoting products as “undesirable… for many readers, the meaning of legal articles from the SFDR will not be clear. As a result, readers are easily misguided.”

C) EU-ESG market trends

1. SFDR carbon footprint “disparity” alleged

Following their recent analysis of SFDR Entity-level PAI statements, one leading news service reported “notable disparities” in asset manager disclosure of investment carbon footprints, “raising doubts about the methodologies used” in the industry.

2. SFDR ‘loophole’ now under Level 1 scrutiny

Speaking at the EC’s recent SFDR Level 1 event, the chair of the EU platform for sustainable finance (also a CNMV board member) cited a “loophole” with SFDR principal adverse impact (PAI) indicators, which currently apply only to a portion of fund assets. As firms are presently able to “exploit and present a misleading picture of fund sustainability”, Ms Viñes Fiestas said it was now necessary for PAIs to be reported for the entire product.

NB: it was subsequently reported that PAIs are now “likely to be targeted for revision” in the current SFDR legal review, given regulators’ current concerns of “gaps in asset managers’ usage of the indicators.”

3. Morningstar: ‘dark-green’ funds buck industry outflows

Morningstar’s quarterly SFDR review remains essential reading.

Key takeaways from the latest edition (Q3-2023) include:

‘Sustainable’ products: market share unchanged at4% [€5.0 trillion AUM];
‘Unsustainable’ products: market share unchanged at 6% [€3.7 trillion AUM];
9 ‘dark-green’ funds: EUR 1.4 billion net QTR inflow (“a new low”);
8 ‘light-green’ funds: EUR 20.5 billion net QTR outflow;
6 ‘non-sustainable’ funds: EUR 17.8 billion net QTR inflow
Re-classifications: 250 x art.6 products upgraded to art.8; 11 x art.9 funds downgraded to art.8.

NB: the document contains analysis of latest European ESG template information, including the ‘Through the Lens of the EET’ section (p.18), alongside PAI indicators under the EET (p.28).