The extensive Q&A aim to provide clarification on the interpretation of both the SFDR and the SFDR RTS across a range of topic areas applying to firms subject to the SFDR including the following:

• Current value of all investments in principal adverse impacts (PAI) and taxonomy-aligned disclosures
• PAI disclosures
• Financial product disclosures
• Multi-option products
• Taxonomy-aligned investment disclosures
• Financial advisers and execution-only financial market participants (FMP)

This note sets out the key Q&A that address points of interpretation of the SFDR and/or the SFDR RTS.

Current value of all investments in PAI and Taxonomy aligned disclosures

Meaning of “current value”- Q.1.1 (page 4)

The basis used to calculate the “current value of all investments” applying to investments in investee companies for the PAI disclosures in Annex 1 of the SFDR RTS should be consistent with the definition of the “investee company’s enterprise value” as defined in clause (4) of Annex 1 to the SFDR RTS. 

Meaning of “all investments”- Q.1.2 (page 4)

“All investments” is a term used in both the PAI disclosures in Annex 1 of the SFDR RTS and in the calculation of Taxonomy-alignment referred to in Article 17 of the SFDR RTS. The Q&A clarify that “all investments” should be understood to mean both direct and indirect investments funding investee companies or sovereigns through funds, funds of funds, bonds, equity instruments, derivative instruments, loans, deposits and cash or any other securities or financial contracts. This wide definition includes elements that firms may not have interpreted as an “investment” such as deposits and cash.  Firms that have excluded cash or other elements that would fall within the definition of “investment” as clarified by the ESAs may need to re-evaluate such calculations to ensure they meet the new definition provided by the ESAs.

Incorporating short positions within the PAI indicators – Q.I.3 (page 5)

Annex 1 of the SFDR RTS sets out the template for disclosure of the PAI sustainability impacts statement.  Some firms have been looking for clarity as to whether short positions should be included in the PAI indicators.  The ESAs are of the view that publishing short positions separately from the main calculation would not help the comprehensibility of the PAI disclosures. Instead, firms should adopt the net short position calculation methodology under the EU Short Selling Regulation (Regulation (EU) No 236/2012).  The PAI of long and short positions should also be netted at the level of the individual counterpart (investee undertaking, sovereign supranational, real estate asset), but without going below zero.

PAI disclosures

PAI data sources and proportion of PAI data which is estimated – Q.II.1 (page 6)

For the disclosures required by Article 7(1)(e) of the SFDR RTS regarding data sources for PAI policies, the ESAs confirm that it would be good practice but not obligatory for FMPs to include information on the following, expressed as a percentage of the current value of the investments included in the calculation:

• The proportion of investments for which the FMP has relied on data obtained directly from investee companies in order to calculate the corresponding indicator; and
• The proportion of investments for which the FMP has relied on data obtained by carrying out additional research from third party data providers or external experts or making assumptions in order to calculate the corresponding indicator.

The suggested categorisation may provide a further challenge to firms who are struggling to gather the required PAI data, so it may be welcomed that the above approach is not mandatory.

PAI reporting for delegated mandates – Q.II.5 (page 7)

For product level reporting, it is clear that the ESAs expect disclosure on PAI to cover all investments of the product, irrespective of whether the investment management of the product is delegated or not.  At the FMP level, all investments should be included in the reporting disclosed by the delegator.  This may cause an issue for firms that have not set up the necessary systems in order to include the delegated investments (if they are in-scope of PAI requirements) into their own investments disclosure, particularly given the now tight timescale in which to operationalise this requirement.  

Quarterly PAI reporting – Q. II.6 and Q.II.7 (pages 8-11)

To strengthen the comparability of the PAI disclosures, recital 5 of the SFDR RTS suggests that given the portfolios of investments of FMPs change regularly across the financial year, the PAI annual disclosure calculation should be based on the impacts at four quarterly snapshots within the year.  Nonetheless, the Q&A clarify that the PAI disclosures required are annual disclosures to be published on the FMP’s website, and so data will not need to be obtained or disclosed by firms on a quarterly basis. 

PAI reporting around asset classes not relevant to a firm Q.II.11 (page 12)

If an FMP makes no investment decisions resulting in investments in certain asset classes set out in the template in Table 1 of Annex 1 of the SFDR RTS (e.g. “sovereigns and supranationals” and “real estate assets”), those sections of the Annex can be left empty or completed with zero values.

Financial product disclosures

The following Q&A address key points of interpretation of the Level 1 text of the SFDR:

Good governance – Article 8 products -  Q. III. 3 (page 16)

This Q&A relates to how an FMP should assess whether the requirement to follow “good governance practices” has been followed when disclosing a financial product under Article 8 SFDR.  Articles 28(b) and 41(b) of the SFDR RTS require the website disclosures to include “the description of the policy to assess good governance practices of the investee companies… including in relation to sound management structures, employee relations, remuneration of staff and tax compliance”. The ESAs clarify that the use of reference metrics such as UN Global Compact, OECD or ILO principles is not prescribed but could form part of the “policy to assess”.  It is helpful that the ESAs confirm there are no mandatory metrics that need to be used in order to satisfy this particular disclosure requirement.

Sustainability risks disclosures – Article 6 SFDR – Q. III. 4 (page 17)

The Q&A contains an important clarification requiring Article 6 SFDR.  FMPs must provide their reasons for considering that sustainability risks are not relevant  (the ESAs describe this as an “unlikely situation”). This confirmation will require firms who have previously taken the view not to make any Article 6 disclosures regarding sustainability risks to revisit this requirement and to ensure they provide a “clear and concise” explanation why they do not consider sustainability risks to be relevant. 

Sustainable investments - Article 8 / 9 SFDR – Q.III.6 (page 17)

The ESAs confirm that firms may define their own “substantial contribution” criteria, provided that they ensure adherence to the letter of Article 2 (17) SFDR (the sustainable investment definition).  However, once defined, firms should not interpret the “substantial contribution” criteria differently for the various financial products that it makes available.

Products invested according to discretionary mandates or client guidelines – Q.III.5 (page 17)

This Q&A clarifies that even where a firm is following its client’s investment guidelines for a managed account or the product is invested according to a discretionary mandate, this does not affect the potential application of Article 8 or 9 SFDR.  Firms who assumed that managed accounts would not fall under the requirements of Article 8 or 9 SFDR (on the basis that they were following a client’s own investment guidelines) will now need to review any managed accounts to check whether the requirements of Article 8 or 9 SFDR are in fact relevant for those products.

Multi-option products

Section IV of the Q&A sets out how SFDR disclosures should be approached for multi-option products (MOPs).  A key point to note includes the following clarification:

“underlying investment options” only apply to IBIPs – Q.IV.4 (page 20)

Article 21 of the SFDR RTS sets out the disclosure requirements in relation to financial products with “underlying investment options” that all have sustainable investment as their objective. The Q&A clarifies that the “underlying investment options” provisions were drafted to only apply to Insurance-Based Investment Products (IBIPs) according to the PRIIPs Regulation and to PEPPs that offer the consumer a choice of different underlying options.

Additional Q&A covered by this section address questions around using hyperlinks for pre-contractual disclosures, how product information for MOPs should be disclosed and the circumstances where a MOP falls under Article 5/6 of the Taxonomy Regulation.

Taxonomy-aligned investment disclosures

Key points from this section V include the following:

SFDR Article 9 products that are partly taxonomy-aligned – Q.V.3 (page 22)

The technical screening criteria in the Delegated Acts for the Taxonomy Regulation provide the conditions under which economic activities can be considered "environmental sustainable" and, therefore, Taxonomy-aligned.  The requirements under the do not significantly harm (DNSH) test in Article 2 (17) of the SFDR are to be applied to all sustainable investments including Taxonomy-aligned investments.  Therefore Article 9 SFDR financial products with a proportion of Taxonomy-aligned investments are nonetheless required to meet the SFDR requirements, in addition to satisfying the technical screening criteria under the Delegated Acts for the Taxonomy Regulation.   This reiterates that firms will need to conduct a separate and additional DNSH assessment under SFDR that they may not have previously planned before.

Pre-contractual and periodic disclosures – Q.V.7 and Q.V.8 (page 24)

The disclosure of the minimum extent of Taxonomy-alignment of investments of the financial product is a commitment that is required to be met at all times. Therefore the pre-contractual disclosure (PCD) should not include “targets” for Taxonomy-alignment, nor the actual achieved level of Taxonomy-aligned investments (this information should be included in the periodic report), but only the minimum proportion which the financial product commits to meet.

Third party reviews under Article 15(1)(b) of the SFDR RTS – Q.V.6 (page 23)

Article 15(1)(b) of the SFDR RTS requires the inclusion of a description of the investments underlying the financial product that are in Taxonomy-aligned economic activities, and whether they have been subject to an assurance review provided by one or more auditors or a third party.  The Q&A confirms that this assurance review is optional.

Financial advisers and execution-only FMPs

Section VI of the Q&A covers requirements for financial advisers and clarifies that the SFDR does not apply to execution only investment firms.

Next steps

The Q&A is immediately effective. Therefore, all in-scope firms will need to carefully review the Q&A in order to ensure they are in compliance with the expectations of the ESAs. Firms should be mindful that time is running out to make any required adjustments to their current preparations for disclosing in time for the 1 January 2023 SFDR RTS application date.

Given the breadth but also the technical specificity of some of the Q&A, this publication does not seek to analyse the entire Q&A document. Firms should seek further advice regarding the applicability of each Q&A to ensure that they are in compliance with any specific areas relevant to their business, and we are happy to provide bespoke guidance on any aspect.

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