ESAs consult on ESG disclosure templates

Introduction

The EU’s Sustainable Finance Disclosure Regulation (SFDR) requires draft regulatory technical standards (RTS) that support the Level 1 text of the SFDR to be submitted to the European Commission by 30 December 2020. This is to allow time for the final measures to be ready by 10 March 2021, when the large majority of the Regulation’s provisions are due to apply – there is, though, a widely circulating rumour that this will now be delayed until 30 December 2021.

On 21 September 2020, the European Supervisory Authorities (ESAs) published a survey seeking feedback on illustrative mock-ups of templates to be used by financial market participants (FMPs) for making pre-contractual disclosures pursuant Articles 8 and 9, and periodic disclosures pursuant to Article 11, of SFDR.

The draft RTS published as part of the ESAs consultation sets out the details of the content and presentation of pre-contractual disclosures and periodic disclosures and includes a requirement to use mandatory reporting templates. The rationale for the use of the templates is to standardise disclosures so that ESG information may be compared across different financial products.

As part of the consultation, the ESAs asked whether respondents agreed with the approach to have mandatory (1) pre-contractual and (2) periodic templates for financial products. A number of responses from consultees commented that the provisions of the draft RTS concerning pre-contractual and periodic disclosures were sufficiently detailed and prescriptive that mandatory reporting templates were therefore unnecessary. The general theme amongst such consultees is that the use of mandatory reporting templates might hamper an FMP’s ability to make ESG disclosures appropriate to the characteristics of a particular financial product and/or the profile of the target audience. Despite requesting feedback on the use of the mandatory reporting templates, it appears that the ESAs have decided to proceed with the use of the templates.

Comments on the templates are invited to be submitted via an online survey by 16 October 2020.

The final content of the templates is subject to the outcome of a concurrent consumer testing exercise and the final report of the ESAs on the draft RTS under SFDR.

Article 8 and Article 9 financial products

The SFDR effectively implements a three-tier categorisation of financial products:

• Financial products with the objective of sustainable investments (including the specific sub-set of a reduction in carbon emissions as an objective). This is effectively the “top tier”, where the objective of the financial product relates to a sustainability objective or impact. These are known as “Article 9” products.

• Financial products promoting environmental or social characteristics. This is effectively the “middle tier”, where sustainable investment is not the objective of the product, but sustainability remains an important and binding aspect of the investment process. These are known as “Article 8” products.

• Other financial products, not falling into either of the above two categories.

What have the ESAs provided?

The ESAs have provided three preliminary illustrative mock-ups of pre-contractual and periodic disclosure templates of financial products promoting environmental and/or social characteristics (Article 8):

• pre-contractual with icons;
• pre-contractual without icons; and
• periodic with icons.

Illustrative mock-ups of pre-contractual and periodic disclosures of financial products with a sustainable investment objective (Article 9) have not been provided with the reason being given that these are very similar to the Article 8 requirements. Whereas this is generally the case, the draft RTS prescribes certain content exclusively to Article 9 financial products (for example financial products with an objective of a reduction in carbon emissions). It is not apparent if there will be the opportunity to comment on illustrative mock-ups for Article 9 financial products at a later date.

One size fits all?

The ESAs have chosen to provide templates in the form of illustrative mock-ups; the form of the templates has been populated for a fictitious exchange traded fund which replicates a fictitious index, called TRXI World Fossil Fuel Free Index, which replicates the total market index TRXI World Index, but excludes companies that own solid fossil fuel reserves.

Providing an illustrative mock-up (as opposed to a simple form, such as the template provided for PRIIPs KIDs) can be useful to financial market participants (FMPs) as a means of illustrating the content and the level of detail that they are expected to disclose. However, it is not clear whether the illustrative mock-ups are intended to provide prescribed language for the disclosures or are intended simply to provide FMPs with an idea of the substance of the disclosures.

Inclusion of prescribed language can be useful. The FMP can be confident that it has provided the content and level of detail required of it and investors are more easily able to compare similar information across different financial products. Prescribed language can potentially also throw up certain difficulties. The prescribed language might be suitable to an ETF however, pre-contractual and periodic disclosures are expected of a wide variety of financial products; the prescribed language may not be suitable for certain financial products, for example, those more innovative or non-traditional financial products that employ their own distinct vocabulary and style. A similar concern arises from the point of view of the investor; the inflexibility of prescribed language does not anticipate an audience which includes individual retail investors and sophisticated institutional investors.

The idea behind the use of mandatory reporting templates is to make it easier for investors to compare different financial products. The mandatory reporting templates mean that all environmental, social and governance information can be found in once place. Whereas this can be advantageous to investors, it is unclear how flexible the set content requirements are and whether additional sections can be added to the template for FMPs to disclose further ESG information that the FMP considers as material to a particular financial product and/or their target investors.

Presentation

The form itself is divided into multiple headings which roughly correlate to the section titles specified in Article 14 of the draft RTS (for pre-contract disclosures of Article 8 financial products) and Article 36 of the draft RTS (for periodic disclosures of Article 8 financial products).

Two versions of the pre-contractual disclosures mock-ups exist, with and without icons. The periodic disclosures mock-up is only available with icons. Each of the mock-ups includes the use of graphs to illustrate asset allocation and sectoral exposure. As part of the survey, the ESAs are seeking feedback on how useful the icons and graphs are visual aids.

A column is included for explanatory notes. It is not clear whether the explanatory notes included are for illustrative purposes (and thus can be amended by the FMP) or form part of the template (and cannot be amended).

The completed templates must be incorporated into the financial product documentation (e.g. the fund offering document). This risks that the presentation of the ESG disclosures section of that document is inconsistent with the layout, vocabulary and style of the rest of the document. Whereas such inconsistency might be useful to an investor as a means of identifying the relevant information, it may also be misleading to investors as they may struggle to reconcile the information in the ESG disclosures, with the remainder of the document (for example, is a “financial product” the same as the “fund” or “portfolio”?).

What should firms be doing now?

Firms that have not already done so should:

• assess the financial products in (and out of) scope of Articles 8 and 9 of SFDR;
• determine what data will be required to populate the templates and identify data sources;
• organise internal processes, including responsibilities, required to complete and approve the completed templates;
• understand the relevant regulatory processes in each relevant jurisdiction that concern updates to, and amendments of, fund documentation and factor this into their timing considerations.
  Firms may also wish to consider responding to the survey, either directly or via trade associations.

How Simmons & Simmons is helping clients

Simmons & Simmons stands ready to advise you on the strategic decisions and practical implementation of your ESG project. Alongside bespoke advice, we’ve produced a menu of services and template documents and policies geared towards helping with you project, including a detailed template project plan, a tool help you categorise products as Article 8, 9 or “other”, template board briefings, risk policies and more. Please contact us for details.

Simmons & Simmons resources

Please visit our sustainable financing and ESG investment microsite for the most up to date information.

We have produced a series of client briefing notes highlighting the key issues for asset managers under the various elements of the EU’s ESG Action Plan. These cover:

• a general overview of the Action Plan;
• the Framework (Taxonomy) Regulation;
• the Sustainable Finance Disclosure Regulation (SFDR); and
• Level 2 changes under AIFMD, the UCITS Directive and MiFID.