The Sustainable Finance Disclosure Regulation: the last piece of the puzzle
New draft regulatory technical standards on information to be provided on products related to taxonomy
On October 22, 2021, the European Securities and Markets Authority (along with other European Supervisory Authorities (ESAs)) published draft Regulatory Technical Standards (RTS) on taxonomy-related product disclosures under the Regulation of the EU on Sustainable Finance Disclosure (SFDR). The RTS project modifies the existing RTS SFDR. This is in line with the desire of the ESAs to create a “single rulebook” for sustainability disclosures.
Where are we on the SFDR?
The SFDR entered into force in March 2021. However, details on how to comply with the main obligations of the SFDR are set out in the SFDR RTS – this remains in the draft stage and its implementation is scheduled for July 2022.
The SFDR contains both entity (or company) level obligations and product (or fund) level obligations. This latest RTS draft updates the product information (i.e. pre-contractual, periodic and internet fund-level information) required for Article 9 and Article 8 funds that achieve sustainable investments with an environmental objective.
What are “sustainable investments” under the SFDR?
The SFDR defines a sustainable investment as an investment in an economic activity that contributes to an environmental or social objective, provided that the investment does not significantly harm those objectives and that the issuing entity follows good governance practices.
Under the SFDR, Article 9 funds have sustainable investment objectives and therefore make “sustainable investments” (although they may also invest in hedging liquidity instruments that correspond to the overall objective of sustainable investment. fund).
Section 8 funds promote environmental or social characteristics. Section 8 funds can (but, unlike Section 9 funds, are not required to) make sustainable investments.
Where Articles 9 and 8 funds make sustainable investments with an environmental objective, Articles 5 and 6 (respectively) of the Taxonomy Regulation (TR) require additional information on the extent to which these investments are aligned with the TR (taxonomy). -aligned). This categorization is illustrated below.
Summary of the main changes
RTS confirms the following:
- Allocation of sustainable investments: for sustainable investments, there must be a disclosure specifying the percentage that has an environmental target and the percentage that has a social target. This applies to both pre-contractual and periodic disclosures. Recital 8 of the RTS recognizes that the proportions stated in the pre-contractual information are targeted. However, this disclosure will be difficult for private investment funds of the closed type because the asset allocation will not be known during the fundraising phase.
- Disclosure of the extent of taxonomic alignment: Article 9 and 8 funds that make sustainable investments with an environmental objective will have to disclose the environmental objectives of the TR to which the investments contribute. There must also be a disclosure on the extent to which the fund’s investments are aligned with taxonomy: this will be in the form of a pie chart with the numerator being the market value of the investments in the issuing companies which represents the proportion of alignment with the taxonomy of the economic activities of these issuing companies. Derived exposures should not be included in the numerator. Two calculations must be produced: one which includes exposure to sovereign bonds in both the numerator and denominator and one which excludes such exposure. Disclosure of the extent to which investments are aligned with taxonomy applies to both pre-contractual and periodic disclosures. For pre-contractual information, the extent to which the fund’s investments will be aligned with the taxonomy should be seen as a target.
- Key performance indicators: for pre-contractual disclosures, a KPI (on turnover, capital expenditure and operating expenses) should be selected to perform the calculation and disclosure with respect to investments in non-financial companies (the turnover being the default KPI). For periodic reporting, all three KPIs should be used and reported.
- DNSH Disclosure for Taxonomy Aligned Investments: Do No Harm (DNSH) disclosure will apply to all sustainable investments, including taxonomy aligned investments. The ESAs had previously considered that the DNSH disclosure should not apply to taxonomy aligned investments, as these must also comply with the technical selection criteria set out in the TR.
The Commission will review the RTS and decide whether or not to approve it within three months of its publication. The Commission intends to integrate all SFDR RTS (those initially submitted to the Commission in February 2021, as well as those discussed here) into a single instrument. Disclosure requirements under the TR regarding climate change mitigation and adaptation goals begin to apply from January 1, 2022, while the expected application date of the SFDR RTS is July 1, 2022.