A) EC gauge feedback for ‘SFDR II’
“Since the SFDR was proposed in 2018, a lot has changed in the world of sustainable finance. Today we are launching an in-depth three-month consultation for stakeholders. We want to know if our rules meet their needs and expectations, and if it is fit for purpose.”
Mairead McGuinness (FISMA Commissioner), 14 September 2023
1. Summary: EC SFDR L1 consultation
On 14 September, the European Commission (EC) formally launched their long-promised industry dialogue, as part of a comprehensive assessment of the Sustainable Finance Disclosure Regulation (SFDR) legal framework.
The EC published two SFDR consultation papers (open for a three-month feedback period):
- Public questionnaire [18 pages]: for individuals, organisations “with only a general knowledge” of EU-ESG
- “Targeted” questionnaire [44 pages]: for public bodies and stakeholders (e.g. financial market participants and regulators) said to be “more familiar” with the SFDR and the wider EU sustainable finance framework, including the Taxonomy Regulation (TR).
The Commission state their interest in “understanding how the SFDR has been implemented and any potential shortcomings”, while “exploring possible options to improve the framework”.
There are over 80 questions in total, grouped into four ‘main topics’ 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]
Both EC consultations run until 15 December 2023; they will be accompanied by a series of EC workshops, starting with an online event on 10 October (to be addressed by Ms. McGuinness).
2. Key EC consultation points
This is currently a high-level discussion, with no detailed proposals.
For now, the EC seek initial opinion from both the public and industry on the current SFDR regime, alongside long-term ideas for revised ‘sustainable’ finance models and disclosure; notable EC paper content includes:
a) Current requirements of the SFDR
The EC enquire if the ‘broad objective’ of their SFDR regime is still relevant; they also cover:
- General data quality: areas where FMPs face challenges in obtaining good quality ESG data, alongside their use of estimates to fill current data gaps;
- Issues faced by stakeholders: legal uncertainty, reputational risks and greenwashing risks;
- Disclosure of principal adverse impacts (PAI): whether all indicators listed in the Level 2 RTS Annex remain material, and challenges related to the product-level Do No Significant Harm (DNSH) assessment;
- Costs of disclosure: if these are “proportionate to the benefits the SDR framework generates”.
b) Interaction with other sustainable finance legislation
In this section, the EC query the alignment of key definitions (e.g. ‘sustainable investment’ per SFDR and ‘environmentally sustainable economic activities’ per TR), alongside the quality of legal guidance (FAQs, Q&As) now available.
They also seek opinion on the new PRIIPs KID ‘sustainability section’, as recently proposed as part of their Retail Investment Strategy (RIS) package.
c) Potential changes to the disclosure requirements for financial market participants
Here, the EC ask whether Entity-level Principal Adverse Impact (PAI) statement is “useful”, and if SFDR is the “right place” for a disclosure that could instead be shared with the separate Corporate Sustainability Reporting Directive (CSRD) regime.
Another key idea floated are ‘uniform’ Product-level disclosure requirements, i.e. “regardless of related sustainability claim”. Future mandatory information disclosed for all products may include:
- Principal adverse impact indicators (i.e. “a limited number”);
- Taxonomy-related disclosures;
- Engagement strategies and exclusions policy;
- Information about how ESG-related information is used in the investment process.
The EC also seek feedback on whether:
- It is appropriate to have product-related information “spread across three places”, i.e. pre-contractual disclosures (PCD), periodic documentation (PD) and on websites;
- Product disclosures should apply “independently” from entity-level disclosures;
- The same PCD template could be used across all SFDR products in scope;
- Product disclosures should take into account underlying investments.
The questionnaire also covers the future accessibility of SFDR disclosures, including:
- Availability within the European Single Access Point (ESAP) “as soon as possible”;
- Introduction of machine-readable formats;
- Layered information made available to investors on websites;
- a “potential regulatory attempt” to digitalise sustainability disclosures by building on the European ESG Template (EET).
d) Potential establishment of a categorisation system for financial products
Finally, the EC considers formally applying a ‘sustainable’ product label to their regime (i.e. similar to the UK’s pending Sustainability Disclosure Requirements (SDR) framework). This was rumoured for many months.
There are two future concepts proposed:
Approach 1: Splitting categories “in a different way” by focusing on the type of investment strategy of the product. Four categories are presented:
- Products investing in assets that specifically strive to offer targeted, measurable solutions to sustainability related problems that affect people and/or the planet;
- Products aiming to meet credible sustainability standards or adhere to a specific sustainability related theme;
- Products that exclude activities and/or investees involved in activities with negative effects on people and/or the planet;
- Products with a transition focus aiming to bring measurable improvements to the sustainability profile of the assets they invest in.
Approach 2: Converting current Articles 8 and 9 into “formal product categories”; this would require legal clarification and additional criteria to define eligibility (e.g. E/S characteristics, sustainable Investment thresholds, DNSH, etc). Here, the ongoing minimum proportion of investments in TR-aligned activities are also questioned.
The EC seek feedback on the consequences of new formalised ‘sustainable’ product categories, e.g. revised:
- Disclosures (e.g. PRIIPs KID, additional SFDR reporting)
- Marketing Communications rules (e.g. use of terms reserved only for products that fall under one of the new product labels: e.g. ‘sustainable’, ‘ESG’, ‘green’, etc)
3. Next steps
The EC consultation is open for three months (until 15 December 2023).
Draft SFDR Level 1 proposals (including revised legal definitions and modified articles) are likely to follow sometime next year, once the EC has absorbed respondent opinions.
As usual, these will entail draft Level 2 delegated legislation (i.e. more updated technical specifications) from the European Supervisory Authorities (ESAs), with additional consultations required to finalise in due course.
Thereafter, one legal firm assumes any resulting ‘SFDR II’ framework changes are unlikely to apply until 2027 (“at the earliest”): it is emphasised the timeframe depends on the priorities of the incoming EU Commission, following the European Parliament election results in June 2024 (i.e. similar to the RIS package).
4. Initial market reactions, predictions
At this early stage, the EC’s consultation has prompted interesting opinions from industry experts and legal firms.
Notable predicted SFDR regime outcomes include:
- Greater legal alignment with both TR and CSRD regimes;
- Entity-level disclosures – reduced: based on streamlined PAI indicators;
- Product-level disclosures – increased: all EU financial products may face obligatory standardised PCD, PD and website disclosures (incl. PAI elements);
- ‘Sustainable’ product labelling: if the EC select either method, FMPs face another substantial re-review / re-categorising of their entire EU product ranges. As a result, many ‘light-green’ funds may lose their current ‘sustainable’
B) Other EU-ESG updates
1. Reminder: “SFDR 1.5”
While the EC’s Level 1 consultation progresses: a reminder that ‘SFDR 1.5’ still needs to be formally resolved.
The industry still awaits feedback from the ESAs, nearly 3 months after a separate consultation on their latest draft Level 2 SFDR/TR technical specifications, which included:
- Introduction of ‘decarbonisation’ targets for Greenhouse Gas (GHG) emissions
- Simplified PCD and PD templates: with “dedicated dashboards” of key information
- Refined list of mandatory of PAI indicators (extended to include additional social factors)
- Amended DNSH assessment and disclosure rules
A formal update from the ESAs is now expected during Q4-2023.
NB: the scope of RTS changes this time around far exceeds the current version (gas, nuclear investments) that was rapidly applied last February; once the latest draft RTS is finalised / legally published, experts assume there will be 2024 transition period, enabling FMPs to revise their SFDR product & entity disclosures where required.
2. CSSF: notify firms of Common Supervisory Action inclusion, next steps
As mentioned in July, ESMA have launched a common supervisory action (CSA) to formally assess the compliance of existing SFDR/TR L2 disclosure rules across EU member states.
To recap: ESMA’s current SFDR CSA will run across all EU member states until Q3-2024, in order to:
- Assess whether market participants adhere to applicable SFDR rules and standards in practice;
- Gather information on greenwashing risks in the investment management sector;
- Identify further relevant supervisory interventions required.
Last week, the CSSF published a communiqué outlining the next steps of their local SFDR CSA activities:
- CSA stage one: local firms must complete a questionnaire covering greenwashing risks
- CSA stage two: local firms must complete a questionnaire covering entity-level integration of sustainability risks and factors in organisational arrangements, plus product-level disclosures.
Luxembourg-based UCITS Managers and AIFMs (in-scope of CSA) were formally notified by the CSSF on 29 August.
Firms that did not receive an email are “not concerned by this exercise”. Ongoing, technical information and respective deadlines “will be shared with the selected entities on a bilateral basis”.
NB: other EU national regulators (e.g. CBI, AMF and BaFin) will contact their local entities in due course.
3. CSSF: MiFID II product governance L3 guidelines to apply from 3 Oct
The CSSF also recently confirmed they will formally apply ESMA’s finalised MiFID II Product Governance guidelines starting from 3 October 2023.
ESMA’s latest ‘Level 3 document’ – including sustainability-related objectives and a new “clustering approach” for target market identification – were formally translated into legal EU languages last month.
The latest CSSF circular states these will apply to investment firms and credit institutions (e.g. providing investment services or performing investment activities). They shall also apply to UCITS management companies and External AIFMs providing portfolio management services or investment advice.
NB: as mentioned previously, we expect FinDatEx to shortly confirm if any changes are required to their European MiFID or ESG templates (EMT, EET) to reflect ESMA’s revised MiFID II Guidance.