On 14 September 2023, the European Commission (Commission) published a public consultation and a targeted consultation on the EU Sustainable Finance Disclosures Regulation (SFDR). The targeted version of the consultation (Consultation) provides important insight into the potential future of the SFDR regime. The SFDR has been law in EU Member States since 10 March 2021.
The Consultation has revealed that the Commission is considering the establishment of a new product categorisation system in acknowledgment that the SFDR has also been used as a de facto labelling regime. In addition, the Consultation explores the Commission’s concerns on how the SFDR has been implemented in practice and how potential shortcomings should be addressed.
We have summarised the five key takeaways for investment managers who fall within the scope of the SFDR, including non-EU alternative investment fund managers (AIFMs) who market funds into the EU.
For further information on the SFDR, see our Sidley Updates:
- EU ESG Disclosures Required from March 10, 2021 — Action Points for Non-EU Fund Managers (January 25, 2021)
- EU Sustainable Finance Disclosure Regulation: European Commission Q&As and Implications for Non-EU Fund Managers (August 5, 2021)
- European Commission Q&A on SFDR — Five Key Takeaways for Investment Managers (June 8, 2022)
1. The Commission is investigating potential issues with the implementation of the SFDR
Sections 1 and 2 of the Consultation deal with the SFDR as it stands today. In particular, Section 1 focuses on the current requirements of the SFDR, and Section 2 focuses on how the SFDR interacts with other sustainable finance legislation in the EU.
The Commission is interested in understanding how the SFDR has been working in practice and in identifying issues that stakeholders have faced when implementing the regulation. In addition, the Consultation explores whether there are inconsistencies or misalignments that exist between the SFDR and other sustainable finance legislation, such as the Taxonomy Regulation.
The Consultation questions allow stakeholders to address some of the key areas of criticisms that the SFDR has faced from the investment management industry. Investment managers that have experienced challenges with reporting under the SFDR may find comfort to know that the Consultation is seeking information on the following topics, among others:
A recurring theme of concern for investment managers since the SFDR became law in March 2021 has been the accessibility and reliability of ESG-related data. The questions in this Consultation may enable the Commission to assess and craft mitigating measures to address this point. For example, the Consultation invites views on whether the SFDR is sufficiently flexible to allow for making estimates and whether there is sufficient legal clarity on when estimates are allowed.
2. The Commission is exploring the establishment of a categorisation system for financial products
The Commission has observed that, while the SFDR was designed as a disclosure regime, it has been treated as a labelling scheme in practice. As a result, there have been persistent concerns that the current market approach may lead to risks of greenwashing, given that the SFDR’s terms and concepts were not conceived for labelling purposes.
In response, the Commission is seeking views on the merits of developing an EU-level product categorisation system based on precise criteria, which is explored in Section 4 of the Consultation. In addition, the Commission considers whether and how current product-level disclosure requirements should be adapted accordingly in Section 3 of the Consultation (this section is discussed further below).
The main topics of query:
- What are the advantages of establishing sustainability product categories?
- How these categories should work (e.g., should there be a distinction between products depending on their sustainability objectives or sustainability performances, and what information should be required)?
- Which types of investors would find product categories useful?
- How should the regime be set up (e.g., what governance systems should be in place; should there be linkages with product-level disclosures)?
The Commission has suggested two, broad, potential pathways for developing a more precise product categorisation system:
- Build on existing concepts. This first option suggests developing the distinction between Article 8 and 9 products and the existing concepts embedded in them (such as “sustainable investment” or “do no significant harm”). These existing concepts could be complemented by additional criteria that define the scope of each article more clearly.
- Develop new approaches to categorisation. This second option suggests focussing on new approaches, such as the type of investment strategy with criteria that do not necessarily relate to the existing concepts. In such a scenario, concepts such as environmental/social characteristics or sustainable investment and the distinction between current Articles 8 and 9 of SFDR may disappear altogether from the transparency framework.
The potential introduction of a product categorisation regime would be a significant change for the investment management market in the EU. In particular, a large portion of the Consultation is dedicated to this topic, which suggests that it is a serious consideration for the Commission.
The creation of a labelling regime under the SFDR would bring the EU’s framework closer to the sustainable finance regulatory framework that the UK government has been developing. The Financial Conduct Authority is expected to publish the final rules for the UK’s Sustainability Disclosure Requirements (UK SDR) before the end of 2023, which will set out the UK’s own labelling regime. For further information on the UK SDR, please see our Sidley Update Financial Conduct Authority Consultation on UK Sustainability Disclosure Requirements — Five Key Takeaways for Asset Managers (November 14, 2022).
We note that the U.S. Securities and Exchange Commission (SEC) is expected soon to publish its ESG rules for investment advisers; the related SEC proposal contains labels for funds (“Integration Funds,” “ESG-Focused Funds,” and “Impact Funds”). For further information on the SEC proposals, please see our Sidley Update SEC Proposes New ESG Disclosures for Investment Advisers and Funds (June 2, 2022).
As a result, a key concern for investment managers would be ensuring that any potential labelling regime is carefully introduced and designed to be interoperable with the investment labels or sustainable finance frameworks of other key jurisdictions, such as the UK and U.S., to limit confusion as well as reduce the associated compliance burdens on investment managers of complying with multiple labelling regimes.
3. The Commission is querying the usefulness and appropriateness of entity-level disclosures being housed under the SFDR framework
Section 3 of the Consultation considers the future of the SFDR and covers potential changes to improve the current disclosure requirements.
The Consultation poses questions in relation to entity-level disclosures. These relate to requirements on in-scope entities to publish website disclosures on sustainability risks, consideration of PAI, and remuneration policies under Articles 3, 4, and 5.
- Is the SFDR the right place for including entity-level disclosures, given that other EU legislation require entity-level disclosures (such as the transparency requirements on sustainability for businesses in the Corporate Sustainability Reporting Directive)?
- To what extent is there room for streamlining sustainability-related entity-level requirements across different pieces of EU legislation?
In terms of entity-level disclosures, the Commission has posed interesting questions regarding the usefulness and appropriateness of housing such requirements in the SFDR. This may be a particular area of interest for investment managers to follow as the utility of entity-level disclosures has recently been brought to attention.
In particular, investment managers that consider PAI (such as managers with more than 500 employees) were required to publish their first full Principal Adverse Sustainability Impacts Statement (PAI Statement) by 30 June 2023 to set out how the firm considers PAI on an entity-level basis.
However, market participants have observed that it is difficult for end-investors to make meaningful comparisons between the PAI Statements of different investment managers. This is because, while investment managers must follow a prescribed disclosure template, they can take different approaches to reporting in practice. For example, differences may arise in terms of scope, asset mix, treatment of data sources, and reporting methodologies.
In addition, given that certain entity-level disclosures may simply be aggregating and generalising PAI policies that are derived from the firm’s products, some market participants have questioned whether the overall disclosures provided at the entity level offer meaningful and sufficiently specific disclosures.
Finally, non-EU AIFMs (with more than 500 employees) marketing funds into the EU are faced with having to prepare entity-level disclosures, even if they market a single fund in the EU out of potentially a large number of funds they manage. It remains to be seen how stakeholders will respond and whether the Commission will look at streamlining sustainability-related, entity-level disclosure requirements with other similar requirements across different pieces of EU legislation.
4. The Commission is querying whether the EU should impose standardised product-level disclosure requirements regardless of the product’s sustainability-related claims
In Section 3, the Consultation poses questions regarding product-level disclosures under Articles 6-11 of the SFDR. These articles relate to requirements on information that must be included in pre-contractual disclosures, in periodic documentation, and on websites.
The Commission is interested in collecting feedback on what transparency requirements stakeholders consider useful and necessary. In light of the potential establishment of a categorisation system (as discussed above), the Consultation also queries whether and how these transparency requirements should link to different potential categories of products.
- Should the EU impose uniform disclosure requirements for all financial products offered in the EU, regardless of their sustainability-related claims?
- Is it appropriate and user-friendly to have product-related information spread across three places, that is, in pre-contractual disclosures, in periodic documentation, and on websites?
In this section, the Commission shows particular focus on determining the transparency requirements that stakeholders consider useful and necessary, such as Taxonomy-related disclosures, engagement strategies, exclusions, and disclosures about how ESG-related information is used in the investment process.
In this regard, the Commission interestingly queries whether it would be useful to have uniform sustainability-disclosure requirements for some or all financial products offered in the EU, regardless of their sustainability claims.
On the face of it, the potential introduction of uniform disclosure requirements for financial products could present a significant departure from the SFDR’s current approach. However, the impact of such a policy would ultimately depend on how the Commission assesses the feedback it receives regarding the appropriate criterion for triggering reporting obligations and the minimum types of disclosures that should be required.
5. The Commission is considering the SFDR’s role in mitigating greenwashing
Notably, the Consultation also looks at marketing communications and product names and the potential risks of misleading investors. This follows from the EU’s continued focus on addressing greenwashing, which includes the recently published progress report from the European Supervisory Authorities (ESAs) on greenwashing in the financial sector (see our UK/EU Investment Management Update (June 2023) for more detail).
The questions in Section 4 of the Consultation hint that the Commission is also looking at whether naming and marketing rules should be introduced to deal with the accuracy and fairness of communications from products.
Currently, Article 13 of the SFDR empowers the ESAs to develop implementing technical standards (ITS) on how marketing communications should be presented. However, the ESAs have yet to propose any such ITS.
The Commission has asked for feedback on the Consultation by 15 December 2023.
Some investment managers have expressed fatigue with SFDR compliance given that the regime has been subject to additional regulatory guidance and clarifications from the Commission and the ESAs. This has required many investment managers to respond with corresponding changes to their internal reporting practices (such as downgrading Article 9 funds to Article 8).
However, managers should take comfort that any substantial changes to the SFDR or the introduction of a new labelling regime would take time before coming into effect. The Consultation has made clear that the Commission is consulting on only broad topics at this stage to consider the outlook for the SFDR.
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