ESG: ESAs ask the Commission for clarity on aspects of the SFDR

On 13 May 2022, the European Supervisory Authorities (ESAs) published a series of ten questions on various aspects of SFDR and the Taxonomy Regulation, which  they have referred to the European Commission (Commission) for interpretation.

The questions are grouped under the following five topics

• principal adverse impact (PAI) disclosures

• financial advisers

• transparency of the integration of sustainability risks and rules for products no longer made available

• good governance practices

• the scope of Article 5-6 of the Taxonomy Regulation

It should be noted, though, that there are still a number of important questions as to interpretation of the SFDR, which the ESAs have not raised.

These include, in particular, key outstanding issues such as:

• the definition of "sustainable investments"

• whether manager level PAI reporting covers all products managed, regardless of whether or not the individual products adhere to the policy

• PAI reporting obligations in respect of asset classes which are not covered by Annex I of the SFDR.

Although it's certainly true that, if you don't ask a question, then you don't run the risk of receiving (and being bound by) an answer you didn't want, the lack of clarity surrounding these issues is leading to different managers taking different approaches, and none being sure which is correct - hardly ideal just over six months away from 1 January 2023, when the Level 2 measures kick in.

Looking at the ESAs' questions in more detail

Principal adverse impact (PAI) disclosures

Question 1:

Are financial market participants (FMPs) that

• are below the threshold in Article 4(3) and (4) of the SFDR and

• choose not to consider adverse impacts of investment decisions on sustainability factors at entity level

able to indicate that they do consider PAI at product level only for a certain subset of financial products?

Put another way, can the FMP decide not to consider PAI at entity level but still consider it under Article 7 of the SFDR for some of the financial products it manages? And, if so, can they disclose this under article 4(1)(b) of the SFDR?

S&S comment on Q1: We will be interested to see the Commission's view on this issue - on the practical side of things, we have seen a good number of firms take the view that it's not permissible to do product-level PAI without first doing manager-level PAI.

Financial advisers

Question 2:

When providing MiFID II investment advice, do financial advisers have to make disclosures under Article 6(2) of the SFDR in good time before the client is bound by any agreement

• for the provision of investment advice "as a whole" (i.e. not just financial products as defined by the SFDR) or

• for each single recommendation concerning a "financial product" as defined by Article 2(12) SFDR?

Question 3:

In respect of PAI disclosures under Article 4(5)(a) SFDR, where a financial adviser recommends financial products that are not collective or individual portfolios managed by a FMP, does it also need to collect information from non-financial companies for those products and take those into account for the PAI disclosure? 

Question 4:

Should a financial adviser which only considers products which are outside the scope of the SFDR as part of its advisory process, still comply with the obligations under Articles 3, 4, 5, 6 and 13 of the SFDR?

Question 5:

Article 17 of the SFDR exempts specified insurance intermediaries and investment firms which provide investment advice, provided that they employ fewer than three persons. As neither "employ" or "employee" is a defined term in the SFDR, how should self-employed staff, owner managers or part-time employees be counted?

Transparency of the integration of sustainability risks and rules for products no longer made available

Question 6:

Do Articles 6 and 7 of the SFDR apply

• only for new financial products or also

• for financial products existing on 10 March 2021 (even if the financial products is no longer available to investors)?

And do Articles 6 and 7 of the SFDR apply for existing portfolio management financial products?

Question 7:

Do financial products no longer made available to new investors have to:

(a)   update and deliver pre-contractual disclosures (Article 6 and 7 of the SFDR) and

(b)   provide website and periodic disclosures (Articles 7, 10 and 11 of the SFDR)

to existing investors?

S&S comment on Q6 and Q7: From the various examples we have seen, it is clear that many firms have taken the (to our mind, commercially sensible) approach that they were required to re-paper existing mandates and re-paper existing open funds, but not to do so in respect of closed funds.

Good governance practices

Question 8:

Where a financial product which makes disclosures under Article 8 or 9 of the SFDR but does not invest in companies with good governance, can that product continue disclosing under Article 8, 9 and 11 of the SFDR?

Question 9:

The reference to good governance in Article 8 of the SFDR relates only to 'companies'. Further, Article 9 of the SFDR (via the definition of 'sustainable investment' in Article 2(17)), specifically relates to 'investee companies'.

Bearing this in mind, can a financial product be considered to fall under either Article 8 or Article 9 SFDR if it invests solely in government bonds while applying an ESG investment strategy?

S&S comment on Q8 and Q9: We have seen divergent views on how firms approach good governance and consider that clarity would be helpful (provided, of course, that the Commission's answer permits investment in non-corporate assets).

Scope of Article 5-6 TR

Question 10:

Taking a financial product referred to in Article 8 of the SFDR, which promotes environmental characteristics and which does not commit in its precontractual disclosures to invest in any economic activities that contribute to an environmental objective (within the meaning of Article 2(17) of the SFDR):

• is the FMP obliged to disclose the information required by Article 6 of the Taxonomy Regulation? and

• if the same financial product is, in fact, found to have invested in such economic activities, is the FMP obliged to make that disclosure?

Similarly, where an Article 9 of the SFDR financial product has only committed in its precontractual disclosures to invest in economic activities which contribute to social objectives but is later found to have invested in economic activities contributing to an environmental objective, would the FMP be obliged to disclose the information required by Article 5 of the Taxonomy Regulation?

What happens next?

The Commission will need to consider and respond to the request for clarity from the ESAs. Clearly, the questions won't have come out of the blue as far as the Commission is concerned, and we can expect there to have been a number of discussions on them already.

Even so, responding formally will not be something which the Commission will take lightly nor will want to rush.

Firms will be wanting answers as quickly as possible but, for the time being, it is unclear how much notice they will get (and how much the answers put forward by the Commission will ease their compliance burden) ahead of 1 January 2023.