ESG: the ESAs propose significant changes to SFDR level 2 RTS

What’s been published?

On 12 April 2023, the three ESAs (the EBA, ESMA and EIOPA), jointly published a consultation paper, "Review of SFDR Delegated Regulation regarding PAI and financial product disclosures" (the CP).

This proposes significant changes to the existing disclosures required under the SFDR – if not exactly SFDR 2.0, then perhaps SFDR 1.5.

In overview, the proposals include substantial changes to the PAI indicators (including additional social indicators, and refinements to calculation methodologies), proposed changes to the do no significant harm (DNSH) aspect of the sustainable investments definition, and material amendments to the mandatory disclosure templates for article 8/9 products.

This note provides a high level summary of the CP – we will be publishing a fuller client note shortly.

What’s the background to this?

The CP follows a mandate to the ESAs from the European Commission in April 2022 to review and revise the SFDR Delegated Regulation (the SFDR RTS) published in July last year with respect to the content and presentation of information regarding:

• the ‘do no significant harm’ (DNSH) principle, in particular:
  • the content;
  • methodologies; and
  • presentation of information in relation to sustainability indicators and adverse sustainability impacts; and
• the promotion of environmental or social characteristics and sustainable investment objectives in pre-contractual documents, on websites and in periodic reports.

What does the CP cover?

The purpose of the review ordered by the Commission was to:

• address “some technical issues” that have emerged concerning sustainability indicators in relation to principal adverse impacts (PAI); and
• propose amendments to the RTS disclosure regime to include greenhouse gas (GHG) emissions reduction targets, including intermediary targets and milestones and actions pursued.

The ESAs have also taken the opportunity to propose adjustments to other sections of the SFDR RTS.

The CP notes the Commission’s concern that transparency and comparability on the sustainability impact of financial products is not keeping pace with an increased demand for high quality sustainability information on the underlying sustainability profile of issuers and on the methodologies underpinning ESG ratings and data in general.

As a result, the Commission has started a review of the SFDR RTS to cater for the increased need for transparency in areas that extend beyond the environment.

As a guiding principle in its work, the Commission intends that any amendments to the RTS should:

• require well-substantiated evidence that investments align with the safeguards in order to reduce the risk of ‘false certainty’ and potential ‘safeguards washing’; and
• be carefully calibrated so disclosures are proportionate and feasible for financial market participants (FMPs).

In their work, the ESAs have also turned to the Q&As adopted on the SFDR, issues raised by the NCAs and desk-based research performed in when drafting annual reports on the extent of PAI reporting under Article 18 of the SFDR.

(For more information on the Commission’s and ESMA’s Q&As on the SFDR, see our articles here, here and here.)

The ESAs have gone beyond the Commission’s mandate and set out, in the CP, proposals on:

• the existing disclosures of DNSH, which they view as “leaving too much discretion to FMPs”;
• potential simplifications of the current templates, which they accept are often considered too complex and difficult to understand by retail investors; and
• a number of other technical adjustments meant to facilitate the use of the templates and the application of the standards.

What happens next?

The consultation period closes on 4 July 2023.

The Commission’s mandate required the ESAs to produce proposed amendments by 28 April 2023 (a year after they received the Commission’s letter).

However, by their letter dated 26 October 2022, the ESAs notified the Commission that ‘significant challenges’ meant that there would be a delay of at least six months (i.e., to at least 28 October 2023) before they could deliver the draft RTS.

These will be submitted as a final report to the Commission. The Commission would then be expected to endorse and adopt the draft RTS.

The adopted legislative proposal would then be scrutinised by the European Parliament and the Council of the EU before being published in the Official Journal.

Although difficult to speculate on how quickly the process could move, it might be realistic to expect the final Delegated Regulation to be published in the OJ in Q4 2023 (perhaps Q1 2024) – however, the ESAs have not included in the CP an indicative timeline for how soon after publication the new rules should come into effect. We will be keeping this under close review and reporting when there is any movement.