European Commission delays application of SFDR Level 2 RTS

UPDATE 3 November 2020

Since we published the article below, the European Commission has written to the Chairs of ESMA, the EBA and EIOPA to confirm formally that implementation of the SFDR Level 2 measures will be delayed to 'a later stage'.

The letter also sets out the Commission's position that the date of application of the Level 1 text remains 10 March 2021.

The European Commission (Commission) has confirmed in a letter to trade associations that the regulatory technical standards (Level 2 RTS) which underpin the EU's Sustainable Finance Disclosures Regulation (SFDR) will be delayed. This formalises a widely circulating market rumour.

The revised compliance date for the Level 2 RTS has not been specified, however it is likely to be January 2022. However, it will still be necessary for firms to comply with the Level 1 SFDR in full, as from the original compliance date of 10 March 2021. 

In this note, we provide more details on the delay to the Level 2 RTS, as well as guidance and views on what this means for the requirement to comply with SFDR itself, without the Level 2 RTS in place. 

For more information on SFDR generally, please refer to our client briefing notes here.

Commission's letter to trade associations

The Commission has written to two trade associations, the Italian Assogestioni and the German Bundesverband Investment und Asset Management (BVI), in response to their calls for a general deferral of the SFDR requirements.  Although it's not been formally published, we understand that the letter is being informally shared with other trade associations.

In our view, firms would be on safe ground to treat this letter as a (semi-)official confirmation of the delay to the Level 2 RTS.

Confirmation of the delay to the Level 2 RTS

The Commission's letter confirms that the application date for the Level 2 RTS will be delayed:

"In order to provide financial market participants and financial advisers as well as supervisors with time for implementation, the Regulatory Technical Standards will become applicable at a later stage." 

The letter does not specify what that deferred deadline will be but it may be inferred that it will be after 2021 and likely January 2022.

This delay will be seen as good news by many in the financial services industry, who were struggling to comply with the Draft Level 2 RTS ahead of the March 2021 deadline.

However, it's important to emphasise that the letter is not a delay of the entire SFDR disclosure regime.  Instead, the Commission confirms that the Level 1 SFDR regulation will come into effect on 10 March 2021. 

The letter states that:

"in the absence of the regulatory technical standards, nothing prevents financial market participants and financial advisers from complying with the level 1 requirements laid down in [SFDR]. Therefore, all application dates are maintained, as laid down by [SFDR]. In consequence, in 2021, financial market participants and financial advisers subject to [SFDR] will need to comply with its high level and principle-based requirements."

So what does this mean for firms?

The story so far

SFDR is a level 1 text, meaning that it sets out the framework principles on sustainability related disclosures in the financial services sector.  

The Commission can then supplement this framework with greater detail through Level 2 measures, developed with the help of consultative bodies such as the Joint Committee of the European Supervisory Authorities (ESAs).

Certain provisions of SFDR contain requirements for the ESAs to develop Level 2 RTS, which must be submitted to the Commission by 30 December 2020 and then adopted to apply from 10 March 2021.

The ESAs' consultation on ESG disclosures opened on 23 April 2020 and closed on 1 September.

On 21 September, the ESAs launched a survey on how the information to be disclosed pursuant to Article 8(3), Article 9(5) and Article 11(4) of SFDR (i.e. pre-contractual and periodic disclosures) should be presented. The consultation period will run until 16 October 2020.

It had however become apparent that the final Level 2 RTS would not be ready in time for firms to comply with it by 10 March 2021.  The ESAs had already indicated that the Level 2 RTS would not be finalised until January 2021 at the earliest.  There was significant industry pushback on some of the provisions in the Level 2 RTS, and the ESAs are revising some of the proposals in response to this. Overall, a delay to the Level 2 RTS will be seen as a positive development.

What happens next?

SFDR will still be legally binding on 10 March 2021, even if certain provisions require Level 2 RTS support.

The letter provides some guidance to firms on how to approach SFDR in view of the Level 2 RTS delay:

• SFDR provisions that do not require Level 2 RTS measures:

  • These will continue to apply from 10 March 2021 - these are predominantly the provisions concerning the integration of sustainability risks in the investment decision making process (Articles 3, 5 and 6 SFDR).

    The Commission notes that "financial market participants, in accordance with applicable sectoral legislation, have to consider already now sustainability risks in their internal processes. The Regulation requires transparency in this respect, with no further details in regulatory technical standards."

• SFDR provisions that do require Level 2 RTS measures:

  • Articles 8, 9, 10 and 11 SFDR (which concern financial product level disclosures to be made in respect of light green and dark green financial products):

    the Commission's letter states that that financial market participants "have to already now describe in product documentations how the bespoke levels of sustainability are achieved. Therefore, the manufactures should already now comply with the disclosure principles set out in Articles 8 and 9 of the Regulation, respectively."

    The compliance date remains 10 March 2021.

  • Article 4 SFDR (concerning entity level website disclosures by financial market participants of adverse sustainability impacts):

    the Commission's letter states that "numerous financial market participants already now comply with the non-financial reporting requirements under [the Accounting Directive] or adhere to international standards and might consider using that information."

    The "comply-or-explain" compliance date is 10 March 2021 with financial market participants subject to mandatory disclosure (Article 4(3) or (4) SFDR) having to comply from 30 June 2021.

So what does it all mean?

The application of the SFDR is not conditional on the formal adoption and entry into force of the Level 2 RTS. As such, the Level 1 requirements will continue to apply generally from 10 March 2021. Firms will, at that point, need to comply with its "high level and principle-based requirements".

In the absence of the Level 2 RTS, the Commission's letter suggests that firms should take a principles-based approach to compliance with those provisions of SFDR that rely upon the implementation and technical standards details set out in the Level 2 RTS. This should be done on an evidenced "best efforts" basis.

Interestingly, the Commission anticipates that firms are already compliant with certain financial product level disclosures by way of applicable sectoral legislation, and that firms may be able to use, or leverage, information disclosed in accordance with existing legislation and standards as a means of satisfying entity level disclosures on day 1.

There is therefore no suggestion that firms should look to the draft Level 2 RTS (including the draft product disclosure templates) as a means of satisfying their obligations under SFDR.

Practical challenge for firms

While superficially helpful, the delay to only the Level 2 RTS raises practical challenges for firms - in particular, how to comply with the Article 4 principal adverse impacts regime, and the Article 8 and Article 9 product disclosure regime for light green and dark green products, without the technical standards. 

In practice, this may require in-scope firms to adopt a two-step compliance. 

• to update disclosures by 10 March 2021 in a high-level and principles-based manner and

• to update again by January 2022 (or such other deadline as is specified) to reflect the formal disclosure requirements of the RTS. 

This may create a documentation headache for firms if they are required to do two repapering exercises of client documentation within a 12-month period.