22 January 2024

EU, UK ESG disclosure update

A) EU sustainable finance disclosure latest

1. SFDR Level 1 review: latest opinion

The European Commission (EC) consultation on long-term SFDR ‘Level 1’ regime changes closed on 15 December.

The outcome of their “comprehensive assessment” may not be known until after the June EU elections.

Meanwhile, the EC idea to convert SFDR into a sustainable product categorisation system still divides the industry.

Latest associations now in favour include:

German BVI: who support “easily understandable” product categories that are “sufficiently general” to work for all asset classes, multi-asset strategies and retail investor sustainability needs;
Institute for Energy Economics and Financial Analysis (IEEFA): who say adopting a labelling system that overlaps with the “similar” UK-SDR would “limit compliance burden and asset owner confusion, enhance transparency and counter greenwashing risk”.

More sceptical groups include:

Investment Company Institute (ICI Global): who state EU fund labelling ”should be voluntary” with “flexible definitions and criteria”; it must also “sit separately from SFDR”;
Managed Funds Association (MFA): encourage the EC “not to overhaul the SFDR framework” as this would “heighten the risk of investor and market confusion” and “render obsolete” the “significant time and resources to comply with the current rules, already invested by asset managers”

2. SFDR Level 2: latest predictions on ESA report

The EC have until 4 March 2024 to approve the latest SFDR ‘Level 2’ technical standards, delivered by the European Supervisory Authorities (ESAs).

Latest expert opinions diverge on the prospects of EU approval and when the RTS changes will legally apply.

One law firm say it’s currently unclear if the revised RTS will be endorsed by the EU authorities and when the proposed changes may take effect.
Another legal firm forecast the draft SFDR RTS will be adopted, with an application date during H1-2025.

At this stage, anyone else trying to make a prediction should bear in mind:

The ESAs admitted they had “gone further than the explicit mandate” during their RTS review;
As a consequence, the EC may require additional review time;
The EC are not obliged to accept the entire revised RTS (e.g. they may proceed with selective parts only);
The European Parliament (EP) must also co-approve the revised Level 2 text, ahead of legal publication;
Before the EU elections, the EP has very few remaining sessions to review the amended SFDR RTS.

Firms planning their next set of SFDR pre-contractual disclosure updates should also recall the varying EU member state formalities in place, last time around (e.g. advance NCA cut-off periods, “fast-track” processes).

3. SFDR Level 3: ESAs revise Q&A

On Friday 12 January, the ESAs updated their SFDR Q&A document. This ‘Level 3’ guidance was previously consolidated in May 2023 to include additional regime clarifications from the EC.

The only noticeable change in the latest Q&A refers to Chapter V. Financial product disclosures.

Question 1 has been amended; this relates to minimum share of ‘sustainable’ investments applicable to ‘dark green’ SFDR article 9 products. Although counter-questions relating to EU Climate Transition and Paris-aligned Benchmarks (EU CTB, EU PAB) have been removed, the original EC clarification point remains intact.

NB: no further Q&A updates are indicated; however, there is now a page increase arising from content formatting in chapters IV (p.19) and VII (p.50), plus one split-text instance (p.51-52).

B) other EU-ESG updates

1. EC advises on latest Taxonomy disclosures

The EU Taxonomy Regulation (TR) goalposts have shifted, again.

Unlike the new UK-SDR regime, EU-SFDR remains formally aligned with a complex classification system determining which EU economic activities are ‘environmentally sustainable’.

The latest technical screening criteria for all six TR ‘environmental objectives’ have been published in the EUOJ:

‘Climate change mitigation’, ‘Climate change adaptation’ [441 pages]: recently updated;
‘Circular economy’, ‘Water & marine resources’, ‘Pollution prevention & control’, ‘Biodiversity & ecosystems’ [164 pages]: published for the first time.

The EC also published a guidance document to support firms impacted by revised TR reporting obligations.

Starting from 1 January 2024, various ‘financial undertakings’ (including asset managers) need to disclose modified key performance indicators (KPIs) in their annual reporting (covering the previous calendar year). These are laid out in the delegated Taxonomy disclosure regulation.

NB: Annex III [‘KPI of asset managers’] is cited in the current SFDR RTS (pre-contractual and periodic disclosures).

2. FinDatEx amend ESG template

On 21 December, FinDatEx updated their European ESG template (EET) to version 1.1.2. This includes:

Typo corrections;
Scope 1, 2 data fields: ‘M’ or ‘C’ indicators changed to ‘O’;
Two new data fields:
- 103 [PAI_Snapshot_Frequency]
- 616 [List_Of_Invested_Countries].

FinDatEx also published an FAQ on use of principal adverse impact [PAI] data fields in the EET.

EET V1.1.2 should be delivered to stakeholders before end-March 2024, to align with the next SFDR entity-level PAI statement.

3. CSSF SFDR data collection deadline pending

The CSSF deadline for the SFDR periodic reporting data collection is Wednesday 31 January 2024.

Last month, the Luxembourg regulator confirmed their online eDesk solution (for manual input of each fund/sub-fund managed by IFMs) is now available, as reflected in their updated User Guide.

NB: a reminder that the current data collection in-progress will be extended in the future, to collect information contained in the PAI statements. Moreover, FMPs must also continue to update the data previously reported under SFDR pre-contractual data collection, by transmitting subsequent declarations.

4. ESMA defer ESG fund name guidance

ESMA have decided to postpone their controversial guidelines on sustainability-related terms in fund names.

They point to provisionally agreed AIFMD/UCITS legal texts, which they say will give them a clear legal mandate to develop general guidelines defining specific cases (including ESG-related) where the name of an AIF/UCITS product is “unclear, unfair, or misleading”. These ‘Level 1’ texts are expected to be published during Q2-2024.

In the meantime, ESMA highlighted interim changes to their original ‘Level 3’ proposals, including the removal of a proposed 50% sustainable investment threshold for funds using sustainability-related words in their name.

ESMA’s finalised sustainability-related fund name guidelines will apply three months after formal publication in all EU official languages. All new funds launched after the application date are expected to conform, with a six-month transition period available for pre-existing products.

5. ESMA publish EU-ESG ‘explanatory notes’

ESMA’s recently issued three explanatory notes covering different aspects of the ‘EU Sustainable Finance framework’. Each document contains an SFDR chapter, referring to financial product disclosures:

‘Do no significant harm’ (DNSH) requirements [14 pages];
Definition of ‘sustainable investments’ [11 pages];
Use of estimates [7 pages].

NB: ESMA state these documents “are not intended to replace relevant legal texts nor to provide guidance on the application of relevant provisions”. Instead, they “aim at setting out factual information regarding these concepts and providing helpful aid to stakeholders to navigate and better understand the legislative framework.”

6. ESMA newsletter packed with ESG market activity

The latest newsletter of the European Securities and Markets Authority (ESMA) was published on 12 January.

Most articles relate to their current sustainable finance activities.

The ‘Making finance work for a sustainable future’ feature (p.9) outlines ESMA’s role in the transition towards a sustainable EU economy, supporting both the European Green Deal and global efforts to address the climate crisis.

This includes a summary of visuals presented to last month’s UN COP28 event in Dubai.

C) UK-ESG developments

1. SDR synopsis

To recap, the UK Sustainability Disclosure Requirements (SDR) regime consists of the following elements:

An anti-greenwashing rule: all firms regulated by the Financial Conduct Authority (FCA) must ensure any sustainability-related claim is fair, clear and not misleading;
Naming and marketing rules for investment product: to ensure use of ESG-related terms is accurate;
Four ‘sustainability’ investment product labels: to manage investor expectations;
Consumer-facing disclosure: to help retail clients better understand key product sustainability features;
Detailed disclosure information: pre-contractual, ongoing product-level, and entity-level disclosures targeted at institutional investors and consumers seeking more information;
Distributor requirements: to ensure product-level SDR information is made available to consumers.

The first SDR milestone will be the 31 May 2024 application of the anti-greenwashing rule guidance.

The consultation on the FCA’s current expectations will end on Friday 26 January.

2. The IA step up to the plate

Kneip are a member of the Investment Association (IA), who now play a major role in assisting UK fund firms meet their SDR requirements, within the time available.

The CEO of the IA was interviewed in the Financial Times. Chris Cummings said that “international consistency and collaboration” are now “crucial to the success” of the SDR regime, with the IA planning to closely monitor EU-SFDR developments (including any changes declared after the 2024 EU election).

The IA’s recent SDR webinar was co-presented with the FCA.

They have formed a new SDR Implementation Forum for their members and will informally collaborate with other trade bodies to identify corresponding sustainable disclosure areas within the European industry.

Both UK-SDR and EU-SFDR will be key discussion topics at the upcoming IA Sustainability Investment Conference (hosted by UBS AM), scheduled for 25 April 2024. Executives from Abdrn, AXA Investment Managers and Northern Trust are among confirmed key speakers.

3. EU firms await OFR clarity

The FCA’s separate consultation on their Overseas Funds Regime (OFR) in open until 12 February 2024.

As before, one crucial SDR clarification point relates to the long-awaited EEA ‘equivalence’ decision to be made by the UK Government. Although SDR rules currently apply only to UK investment products, the FCA acknowledge in their OFR paper their aim “for all schemes marketed to UK investors to be subject to the same requirements”. The FCA say they “will work with HM Treasury to understand the options for extending the SDR to overseas recognised schemes, including those marketing under the OFR”.

In due course, EU-UCITS categorised as SFDR article 8 or 9 products may face additional (diverging) sustainability disclosure rules (and other local reporting), in order to be marketed to UK investors.

4. FCA verify their ESG ‘Guiding Principles’

Prior to issuing the SDR Policy Statement, the FCA made available analysis results showing how effectively authorised fund managers (AFMs) had applied their ‘ESG guiding principles’, published back in July 2021.

This earlier FCA guidance was intended to be “complementary to obligations under SFDR”; it set out an overarching principle (‘consistency’) with three supporting principles covering ‘design’, ‘delivery’ and ‘disclosure’, all valid for local investment funds classed as “sustainable”.

In their findings, the FCA highlight “further improvements may be needed” by certain firms; they now expect AFMs to re-assess how well they are meeting these guidelines, as useful preparation for the SDR rollout during 2024.

D) latest ESG market updates, trends

1. Latest key market statistics

The Luxembourg Times report local “ESG funds” have reached €2.8 trillion AUM (67.3% of total domiciled UCITS). They refer to the latest study issued by the Luxembourg Sustainable Finance Initiative (LSFI).

Morningstar will shortly publish their latest SFDR Article 8 and Article 9 Funds quarterly update; this will summarise the EU sustainability landscape as at end-December 2023. Media channels are still picking over previous findings in their Q3-2023 report, including:

the “unprecedented number” of SFDR article 8 products upgrading proportions of sustainable investments;
the predicted “wave” of SFDR article 9 products that has (so far) failed to appear.

2. SFDR “push back” while firms see SDR “opportunity”

FT Ignites also report “many asset managers” now viewing UK-SDR as “a way to attract investment rather than as a compliance exercise”; this contrasts with the industry “push-back” against the EC’s latest EU-SFDR overhaul.

3. ESAs publish consumer sustainable finance factsheet

The ESAs co-published a factsheet to answer consumers’ frequently asked questions about sustainable finance.

It also provides ‘key tips to keep in mind before choosing financial products with sustainability features’.

4. EFAMA publish retail ESG brochure

The European Fund and Asset Management Association (EFAMA) also recently published a brochure.

‘Sustainable investing explained in 9 questions’ is EFAMA’s latest effort to assist EU citizens with their sustainable investment decision-making.

5. EC assess most liveable European cities

Finally, environmental, social and governance factors resonate in the EC’s new report on the quality of life in European cities; this is based on a survey of 83 cities, with many sustainable development studies mentioned.

Air quality, green spaces, housing, healthcare, inclusion and quality of local public administration are among key aspects considered. The latest overall Top and Bottom 10 cities are listed on page 16.