Earlier this month we reported that the ESAs had asked the Commission various questions relating to SFDR and Taxonomy - see post.

Yesterday, ESMA published a Commission Decision (C(2022) 3051) and Annex containing a set of answers. 

(Whilst this seems like a very speedy turnaround, we note that the questions were sent to the Commission in December 2021 but only published by the ESAs on 13 May 2022!) 

The Commission responses are broadly unsurprising or uncontroversial on most points, but the answers on products which closed prior to 10 March 2021, and on Taxonomy disclosures, are quite unhelpful - see sections 5 and 6 below.

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1. Consideration of PAIs at a product level

  • Due to somewhat confusing wording in the Level 1 of SFDR, the ESAs asked the Commission whether it was possible for an FMP who makes a negative PAI disclosure at entity level to make a positive PAI disclosure at product level. I.e. the FMP would say they do not consider adverse impacts of investment decisions as an entity as a whole (because the FMP does not have 500 employees and has not otherwise chosen to voluntarily do entity level PAI reporting), whilst saying they do consider PAIs with respect to specific products.
  • Helpfully, the Q&As helpfully confirm that the Commission’s view is that PAIs can be considered at a product level, even if the FMP does not consider and report on PAIs at an entity level (despite the Level 1 of SFDR implying a potential linkage between the two obligations).


2. MiFID investment advisers 

  • The Q&As also clarify the scope of the Level 1 obligations for firms providing MiFID investment advice. This is in response to ESA questions on the (somewhat confusing and inconsistent) references to SFDR “financial products” (i.e. certain buyside products in-scope of SFDR) rather than all “financial instruments” (i.e. instruments in-scope of MiFID) – the general clarification is that firms providing investment advice are in scope of the SFDR rules when advising on all MiFID financial instruments and not just SFDR financial products.
  • Therefore, MiFID investment advisers are in scope of the sustainability risks disclosure obligations in Article 3 (entity level approach to sustainability risk integration in advice), Article 5 (sustainability risks in remuneration) and Article 6(2)(a) of SFDR (integration of sustainability risks in recommendations), even when they advise on instruments such as bonds, shares etc. that are not SFDR financial products.
  • However, the position for PAIs under Article 4(5) of SFDR is confusingly different - the Commission takes the view that where financial advisers state that (at an entity level) they consider PAIs in their investment advice, this can be limited to the advice they provide on SFDR financial products only (i.e. there is no requirement to consider PAIs when advising on bonds, shares etc.). However, where a financial adviser states that it does not consider PAIs in its investment advice (at an entity level) it must explain why it doesn't consider PAIs in its advice on all financial instruments (i.e. SFDR financial products and other financial instruments such as shares, bonds etc.).


3. Exemption for insurance intermediaries and investment firms with less than 3 employees

  • The Q&As state that as there is no definition of “employ” or “employees” in the SFDR rules, the headcount figure should apply regardless of the features of the employment relationship i.e. part or full time. However, the Commission’s response does not explicitly deal with some of the aspects of the ESAs’ questions – e.g. whether self-employed staff or owner managers would be counted as “employees”. Although the Q&A is strictly answering quite a niche question (about very small insurance intermediaries), the feedback here is interesting as it will likely be followed by the Commission when interpreting the 500 employee headcount requirement for mandatory entity-level PAI reporting under Article 4 of SFDR.


4. Good governance

  • The Q&As confirm that it is a requirement for Article 8 and 9 products to ensure investee companies they invest in follow “good governance”(i.e. failure to ensure this would be a breach of Article 8 or 9 as applicable). It confirms that the good governance requirement applies to all corporate investments within Article 8 (even where the corporate investment is not being used to meet the E/S characteristic) and 9 products, and not to other types of investments such as sovereign investments.


5. Closed products

  • The Q&As clarify that:
    • All financial products manufactured before 10 March 2021 but were still made available to investors on or after that date - are in scope of SFDR, which should not be a surprise.
    • For financial products that were no longer made available to investors after 10 March 2021 – unhelpfully the Commission takes the view that such products must comply with the SFDR periodic and website disclosures (but not the pre-contractual disclosures). This is an unhelpful development as it retrospectively applies the SFDR rules to products that ceased marketing / closed before SFDR came into effect and FMPs will therefore need to do an exercise to look back at the offering materials for products that still have EU investors (or take risk-based views). In practical terms, however, it should be noted that the SFDR periodic and website disclosure obligations only apply to financial products in scope of Article 8 or 9 (and not other financial products). Hence, products that were not made available to investors after 10 March 2021 would need to be assessed as falling within these categories in the first place for these obligations to apply.


6. Taxonomy disclosures

  • The ESAs asked the Commission for clarity on the scope of Taxonomy disclosures under Articles 5 and 6 of the TR.
  • With respect to disclosures under Article 6 TR (i.e. the type of disclosure that applies to certain Article 8 SFDR products), the Commission echoes the wording of the TR in simply stating that the disclosure applies to Article 8 SFDR products which promote environmental characteristics (whether or not they invest in economic activities that contribute to an environmental objective). The Commission does not address the fact that part of the Article 6 TR disclosure is essentially nonsensical for Article 8 SFDR products that do not have sustainable investments.
  • With respect to disclosures under Article 5 TR (i.e. the type of disclosure that applies to certain Article 9 SFDR products), the Commission again echoes the wording of the TR and states that this applies to Article 9 SFDR products which invest in environmental sustainable investments. However, they do clarify that an Article 9 product which has a social objective will still need to make this disclosure where it does in fact make environmental sustainable investments.
  • Whilst these views are arguably in line with the Level 1 TR, they seem a bit inconsistent with the structure of the disclosures under the SFDR RTS (recently adopted by the Commission). For example, for Article 8 products the section in the SFDR RTS pre-contractual disclosures on Taxonomy alignment is titled in a way that implies it is only needed for Article 8 products with sustainable investments, and this inconsistency is not clarified in the Q&A.
  • A major issue faced by FMPs in making Taxonomy disclosures has been the lack of reliable Taxonomy-alignment data available for their consumption. The Q&A helpfully clarifies that Taxonomy alignment data does not have to just come from issuers which are in-scope of mandatory EU Taxonomy alignment disclosure obligations (so alternative sources can be used). However, it does also state that where FMPs fail to collect reliable data, they should give a Taxonomy alignment disclosure of zero. They also say narrative non-alignment disclosures risk undermining the purpose of Article 5 and 6 TR, and clarifications “should neither leave room for ambiguity about the alignment of the investments of the financial product… nor should they include negative justifications, such as explaining a lack of the alignment by a lack of data”. This is quite unhelpful, as the lack of reliable Taxonomy-alignment data is, in practice, a fundamental cause of FMPs being required to give zero Taxonomy alignment disclosures.
  • The Q&A also reiterates Recital 21 of the TR in noting that commentary assessments and estimates related to Taxonomy alignment assessments should only be used in exceptional cases where FMPs cannot reasonably obtain information to reliably determine Taxonomy alignment, and such assessments and estimates “should only compensate for limited and specific parts of the desired data elements, and produce a prudent outcome”.