Sustainable Finance Disclosure Regulation:

On 24 March 2022, the European Securities and Markets Authority, European Banking Authority and European Insurance and Occupational Pensions Authority (together, the ESAs) published an Updated Joint ESA Supervisory Statement on the application of the Sustainable Finance Disclosure Regulation.

The express objective of the Statement is to “seek to mitigate the risk of divergent application” of the Sustainable Finance Disclosure Regulation (SFDR) and relevant provisions of the Taxonomy Regulation in the “interim period” between the date of application of SFDR, 10 March 2021, and the date of Regulatory Technical Standards (RTS) setting out detail about certain matters, the application of which were delayed at the end of last year until 1 January 2023.

The Statement reiterates the ESAs’ expectations about implementation of SFDR and the Taxonomy Regulation during the interim period by making clear that, regardless of the delay to the RTS, market participants must comply with:

• the “general” obligations set out in SFDR, encouraging use of the draft RTS published in February and October last year as a reference (while noting that they may be subject to change, including as a result of intervention by European Parliament or European Council); and
• the obligations in the Taxonomy Regulation regarding the disclosure of the proportion of investments in Taxonomy-aligned activities (allowing for qualitative explanation of approaches to calculation, where necessary).

The Statement reinforces, rather than diverges from, prevailing market practices – and in that respect is welcome. But it nevertheless emphasises some of the challenges facing market participants in this interim period, and underscores some of the questions that are yet to be fully, or at least adequately, answered.

Application of general principles (Level 1) of SFDR unaffected by delays

It was clear from the commencement of SFDR that disclosures regarding a participant’s approach to the integration of “sustainability risks” (ie ESG risks with a potentially material negative impact on the value of investments) were required to be disclosed on participant’s websites and in pre-contractual materials for specified products (the latter known as Article 6 disclosures).

But SFDR left the detail of a number of other disclosures to be determined in subsequent standards. In particular, SFDR provided for the making of RTS regarding the detailed form of disclosures for:

• Participant approach to adverse impacts of investments – a market participant’s approach to considering “principal adverse impacts” (PAI) of its investment decisions on specified “sustainability factors” (ie the “inside-out” corollary to the “outside-in” sustainability risks);
• Product approach to promotion of environmental and social characteristics – where a product promotes environmental or social characteristics, its approach to meeting those characteristics (known as Article 8 disclosures); and
• Product approach to sustainable investment objective – where a product has a sustainable investment objective, its approach to attaining that objective (known as “Article 9” disclosures).

The European Commission and the ESAs have repeatedly sought to emphasise that the delays in finalisation of the RTS – now proposed to apply from 1 January 2023 – do not affect the general application of SFDR regarding these three areas, explaining that SFDR “lays down at Level 1 general principles of sustainability-related disclosures” for each.

Market participants could be forgiven for a degree of scepticism regarding that statement, particularly when first made by the Commission in late 2020, given the relative lack of certainty regarding key concepts such as PAI, “promotion” and even “sustainable investment objective,” each of which has been the subject of much subsequent debate and clarification.

But whatever the validity of such views at the time, the Statement makes clear the ESAs’ current view that the publication of the two draft RTS since that time have since provided an adequate degree of clarity and “can be used as a reference for the purposes of applying the [relevant] provisions” of SFDR and the Taxonomy Regulation in the interim period. These two draft RTS were published in February 2021 (on disclosures regarding the three areas identified above) and October 2021 (on Taxonomy-aligned disclosures under SFDR).

The guidance set out in the Statement is consistent with prevailing market practice, with most participants having been closely monitoring developments and updating disclosures to reflect, as closely as possible, the requirements of the draft RTS.

But, as the Statement notes, it remains possible that the form of RTS ultimately adopted by the Commission, now intended to be bundled into a single delegated act, could still differ from the draft. The European Parliament and the European Council each have the right to object over a period of three months, capable of extension by a further three months.

Disclosure of Taxonomy-alignment unaffected by delays

The Statement also emphasises that delays to the RTS have no impact on relevant provisions of the Taxonomy Regulation and the “taxonomy-alignment related product disclosures apply in respect of the first two environmental objectives” from 1 January 2022.

This comment relates to requirements under the Taxonomy Regulation that products include information on the extent to which they contribute to one of the six environmental objectives identified in the Taxonomy Regulation. These six objectives are climate change mitigation, climate change adaption, the sustainable use and protection of water and marine resources, the transition to a circular economy, pollution prevention and control and the protection and restoration of biodiversity and ecosystems.

Specifically, the Taxonomy Regulation requires that products disclose:

• if they do contribute to those objectives, by specifying the proportion of investments directed toward “environmentally sustainable” economic activities in connection with those objectives; and
• if they do not contribute to those objectives, by incorporating a specific statement to that effect.

As alluded to in the Statement, only disclosures about the first two objectives – climate change mitigation and climate change adaptation – are currently required, with the remainder currently set to apply from 1 January 2023.

But the Statement makes clear that the delays in the RTS do not constitute a basis for avoiding “explicit quantification” of the extent to which investments are “taxonomy-aligned.” The Statement also makes clear that:

• information regarding “taxonomy-eligible” activities (a concept drawn from the Disclosures Delegated Regulation under the Taxonomy Regulation, describing activities that may be “environmentally sustainable,” regardless of whether they meet specified screening criteria) should not be provided; and
• while estimates should not be used, “where information is not readily available from public disclosures by investee companies” participants may “rely on equivalent information on taxonomy alignment obtained directly from investee companies or from third party providers.”

Though the ESAs’ intentions are clear, market participants could again be forgiven for approaching statements of taxonomy-alignment on a conservative basis, given the challenges around data collection and uncertainty around issues such as what may constitute “equivalent information” across a range of asset classes that are not captured by European reporting frameworks.

The Statement does appear to acknowledge these challenges in part, allowing – at least in this interim period – that a disclosure “could be accompanied by a qualitative clarification explaining how the financial product addressed the determination of the proportion of taxonomy-aligned investments of the financial product, for example by identifying the source of information for that determination.”

But the longer-term challenges – particularly regarding collection and verification of data across a range of asset classes – remain.