The market has received a lot of valuable information on the direction of the EU’s sustainable finance agenda – from the EC’s announcement of the renewed sustainable finance strategy on July 6, 2021, to its responses later this same month to the questions and answers raised earlier this year by the AES (ESMA, EIOPA and EBA).

One of the reasons for the delay in the entry into force of Level II was the need to modify the regulatory technical standards SFDR (“RTS“) of February 2021 to include transparency requirements applicable to certain financial products in accordance with the taxonomy regulation (“TR“). The ultimate goal: to create a single rulebook for sustainability disclosures under SFDR and TR.

Now the RTS we’ve all been waiting for is available. On October 22, 2021, the ESAs finally released the final report² on sustainable development disclosures, including taxonomic disclosures. This final report provides us with the changes to the mandatory templates for financial products, reflecting additional information applicable to Article 5 and Article 6 products under the TR.

Many points that had left the industry wondering for much of 2021 have now been clarified.

But before we explore the latest rules in detail, note that the disclosures related to the SFDR remain largely unchanged (except for some reorganization of the model sections).

An important point to note, however, is that the new models have largely shifted attention away from the only category of financial products (be it Article 8 or Article 9 SFDR) to the issue of find out whether or not the financial product constitutes sustainable investments, in what proportions and with what objectives. This change in focus is aligned with the revisions to the MiFID delegated acts published on June 4, 2021 requiring that the sustainability preferences of end investors be assessed as part of the suitability assessments, in particular in terms of the minimum percentage of sustainable investment by the financial product (among other factors).

Another notable change is that from now on, the ESAs indicate that all sustainable investments will be subject to the SFDR rules relating to the principle of no significant harm. (“DNSH“) (ie taking into account the Main Adverse Impact (“PAI”) Of the indicators in Annex I of the RTS). This includes taxonomy aligned investments, although they already fall under the detailed DNSH rules of the TR technical selection criteria. This removal of a previously proposed exemption is a surprise. This means that the work undertaken so far by financial market players to develop processes to retrieve PAI indicators, either directly from issuers or through third party providers, is now even more crucial. In addition, the information that uses PAIs now encompasses more information: not only about whether a financial product takes into account PAIs on sustainability factors, but also how it does so.

The main changes related to taxonomy concern the rules for calculating alignment (i.e. the rules for assessing the extent to which the economic activities invested are qualified as environmentally sustainable). In addition to details on the treatment of certain asset classes, the most important of these changes concern:

• Treatment of sovereign exposures (eg government bonds). In the absence of a reliable methodology to assess the taxonomic alignment of sovereign exposures, the initial position was to exclude them from taxonomic alignment calculations. However, as this would result in unfair treatment of certain financial products and asset classes, the ESAs decided to require that the taxonomic alignment of investments be disclosed in two ways: one which includes sovereign exposures in the calculation, and one other that excludes them. This means more work for financial market participants, but increased transparency for end investors.
• KPIs to use to disclose taxonomy alignment. In this new version of the RTS, the pre-contractual information on financial products will have to use the same type of key performance indicator (“KPI») For all non-financial companies. By default, this will be turnover. The use of alternative capital expenditure KPIs (“Investment“) or operating expenditure (“Operating costs”) Must now be justified by the characteristics of the financial product, which must show that the use of Capex or Opex leads to a more representative calculation of the taxonomic alignment. However, for periodic disclosures, the ESAs propose that the alignment of taxonomy be indicated for the three KPIs as the basis of calculation for all non-financial companies of a product. Again, this means more work for financial market participants, and more harmonized information easily accessible to end investors.

Finally, the new RTS insists on disclosure that a third party auditor or examiner has certified the demonstration that the economic activities funded by the product are indeed considered environmentally sustainable in accordance with the detailed criteria of the TR (and, in if yes, the name of that third party auditor or examiner).

In summary, the new RTS generally intends to disclose more information to end investors, especially with regard to investments in environmentally sustainable economic activities based on the TR. The aim is to provide transparent and comparable information with which investors can make more informed investment decisions.

And after?

The EC will now consider the new RTS presented in the final report and decide to approve them within 3 months of their publication.

The final rules and the bundled RTS are expected to go into effect in July 2022, giving the industry around 8 months to prepare.

Given their complexity and technical nature, as well as the need to involve various stakeholders within your organizations (such as sales, legal and compliance teams, as well as portfolio management teams) to prepare related disclosures, we urge you all to continue – or to start – actively preparing for the Level II rules. In particular, we advise you to analyze (and complete, if possible) the latest mandatory pre-contractual and periodic models of the RTS applicable to all financial products that promote environmental or social characteristics, and to financial products aimed at investing sustainable.

1 “Level II” refers to regulatory technical standards being developed as additional rules to the SFDR and the taxonomy regulation.

2 Final report on the draft regulatory technical standards concerning the content and presentation of the information to be provided in accordance with Articles 8 (4), 9 (6) and 11 (5) of Regulation (EU) 2019/2088.