On 12 April 2023, the ESAs published a joint consultation paper in response to the joint mandate they received from the EU Commission to review and revise the Regulatory Technical Standards (RTS) set out in the Commission Delegated Regulation (EU) 2022/1288 of 6 April 2022 supplementing the Sustainable Finance Disclosure Regulation (EU) 2019/2088 (SFDR) (the Consultation Paper).  The purpose of the review is to broaden the existing disclosure framework and address some of the technical issues that have arisen since SFDR was originally agreed.

In the Consultation Paper, the ESAs propose the following changes:

• extension and enhancement of the list of social indicators for the disclosure of the principal adverse impacts (PAIs) of investment decisions;

• refinement of the content of other indicators for adverse impacts and their respective definitions, applicable methodologies, metrics and presentation; and

• adding product disclosures regarding decarbonisation (greenhouse gas (GHG) emissions reduction) targets, the level of ambition and how the target will be achieved.

The Consultation Paper also proposes to reduce the discretion and resulting uncertainty arising from the “do no significant harm” (DNSH) test, a key criteria for “sustainable investments” under Article 2(17) of SFDR.  They also propose other technical adjustments concerning, among others, the treatment of derivatives, the definition of equivalent information, and provisions for financial products with underlying investment options.  The Consultation Paper also includes proposed changes to “simplify” the current pre-contractual and periodic disclosure templates (as provided in Annexes 2 to 5 of the RTS) to enhance transparency and retail investor comprehension.

A few of these points we discuss briefly below.

Extension of the list of social indicators for PAIs

Conscious of the data challenges highlighted by financial market participants (FMPs), the ESAs have suggested alignment with the draft European Sustainability Reporting Standards (ESRS) in respect of social indicators for the disclosure of the principal adverse impacts (PAIs) of investment decisions. These proposed social indicators are reported under the Corporate Sustainability Reporting Directive (CSRD) and the ESAs have proposed this change to improve consistency and availability of information.  They have however, also suggested additional mandatory and opt-in indicators which are not, for the time being, reported under ESRS and are seeking feedback on these.  Additionally the ESAs have highlighted the lack of social indicators in relation to investment in real estate assets and discuss further refinement to cater for ‘inefficient real estate assets’.

In order to ensure consistency across sustainable finance legislation, including for the purposes of alignment with the Taxonomy Regulation, the ESAs have suggested amending PAI indicators #10 and #11, by replacing the reference to the UN Global Compact Principles with the UN Guiding Principles and the Declaration of the International Labour Organisation on Fundamental Principles and Rights at Work.  An additional new PAI indicator measuring adverse impact of exposure to companies involved in the cultivation and production of tobacco has also been added in line with the exclusions under the Climate Benchmarks Delegated Regulation.

DNSH design disclosure options

The ESAs have suggested amendments to SFDR itself (Level 1) to counter the significant discretion that FMPs have in the assessment and disclosure of the requirements for “sustainable investments” under SFDR.  The ESAs’ concern is that the current requirements for compliance with the DNSH test are inconsistently applied, undermine the comparability of financial products and could lead to greenwashing.  The ESAs also highlighted difficulties arising due to the interlinkage between environmental PAI indicators and the DNSH criteria in respect of “environmentally sustainable” activities under the EU Taxonomy Regulation (EU) 2020/852 (Taxonomy Regulation).  

In the context of this review, the ESAs have suggested the following options:

• to implement no change, on the basis that the disclosure framework is relatively new (and noting that a further comprehensive assessment of SFDR was already announced in January 2023);

• to introduce quantitative thresholds in relation to PAI indicators in the context of the DNSH test, in order to more objectively determine that a sustainable investment does not significantly harm environmental or social objectives; or

• to introduce an optional “safe-harbour for environmental DNSH”, which would mean that investments in activities that already meet the criteria as “environmentally sustainable” under Article 3 of the Taxonomy Regulation would not also have to meet a further DNSH test in respect of environmental objectives under SFDR. Under this option, the ESAs have proposed including a standardised statement in the product disclosures that certain economic activities that comply with the Taxonomy Regulation do not require further environmental DNSH disclosures.

Amendments regarding decarbonisation targets

A number of financial institutions and products have made “net zero” commitments.  In order to support these ambitions, the ESAs have stated that high quality product level disclosure of any GHG emissions commitments and of progress towards targets is critical in order to allow investors to compare and assess products and therefore make informed investment decisions.  The ESAs have proposed introducing new sections within the template disclosures and responses would only need to be made where a financial product has disclosed GHG emissions reduction targets.

Amendments to the templates

Further to the proposed changes set out in the consultation paper, and summarised above, the ESAs have proposed introducing new versions of the pre-contractual and periodic disclosure templates (Annexes 2 to 5 of the RTS).  The ESAs explain they are conscious of the criticisms that templates are excessive in length and complexity and therefore are seeking input from stakeholders as to possible changes to the language, layout and structure.  Among other changes to the disclosure templates, the ESAs have proposed a new “dashboard” at the start of each template, which they suggest would attract the attention of the reader to the most vital information and alleviate comprehensibility concerns.

Next steps

Comments to the Consultation Paper are requested until 4 July 2023.  The ESAs have promised to deliver the Final Report to the European Commission under the mandate by the end of October 2023 after considering the comments received and having a joint public hearing and targeted consumer testing. In the meantime, funds publishing SFDR disclosures are still required to ensure compliance with the existing requirements under SFDR and to publish using the current versions of the disclosures templates.

Our Sustainable Finance & Investment practice brings together a multidisciplinary global team to support our clients in this mission-critical area. 

This note is intended to be a general guide and covers questions of law and practice.  It does not constitute legal advice.

Authored by Emily Julier, Melanie Johnson, Julia Cripps, and Rita Hunter.