Late in the day given the application of the SFDR Level 2 requirements from 1 January 2023, the European Supervisory Authorities have today published their Q&A on various questions posed by the European Commission on the SFDR Delegated Regulation (EU 2022/1288). 57 Q&As in all, these cover a range of areas including:
- Current value of all investments in PAI and Taxonomy-aligned disclosures;
- PAI disclosures;
- Financial product disclosures;
- Multi-option products;
- Taxonomy-aligned investment disclosures;
- Financial advisers and execution-only FMPs.
The Q&As address important questions of interpretation alongside practical issues for example around the use of templates.
Clarifications on PAI (and some Taxonomy) calculations
Section I of the Q&A provides some general clarifications on how the concept of “current value of all investments” should be understood for the purposes of PAI and Taxonomy calculations. Most notably:
Meaning of “all investments”: Q2 clarifies that “all investments” should include direct and indirect investments (e.g. investments through funds, or funds of funds). Interestingly, it also states that investments could include “deposits and cash”, although it is not entirely clear what is meant by this (e.g. whether they are suggesting that a deposit should be viewed as an “investment” in the relevant bank as is suggested in the SFDR RTS pre-contractual templates). The Q&A also clarifies that “investments” should only include certain investments that are relevant for the given type of FMP, rather than all investments in the plain English sense. Perhaps most notably they clarify balance sheet investments by banks/investments firms should not be included (and instead only portfolio management mandates should be). Interestingly, the Q&A only refer to Article 4 (entity level PAI consideration) while the same would naturally apply to Article 7 (product level PAI consideration) where the portfolio management of the product is only partially delegated to another party.
Net positions: Q3 clarifies that PAI disclosures should be made in relation to net positions with calculations of net short positions using the methodology in the Short Selling Regulation to calculate these. However, they also state that positions in an individual counterpart, whilst they should be netted, should not be netted below zero (presumably to avoid negative PAI calculations).
Section II then focusses on giving guidance about PAI disclosures more generally. Whilst some responses are relatively straightforward clarifications (e.g. of how certain more qualitative PAIs could be assessed or how calculations should be performed) there are some quite interesting points:
Disclosure of data sources: Whilst keen to stress that this is not mandatory, Q1 states it would be “good practice” to include for each PAI considered by the FMP (1) the proportion of investments for which the FMP has relied on data obtained directly from investee companies; and (2) the proportion of investments for which the FMP has relied on data obtained by “carrying out additional research, cooperating with third party data providers or external experts or making reasonable assumptions”. Interestingly (despite the question being on this point), this does not suggest that a firm must specifically disclose what proportion of its PAI data is based on estimates, as the distinction is instead between data obtained directly and essentially all others forms of indirect or estimated data.
Delegation and PAI disclosures: Q5 suggests both with respect to products and entity level reporting that FMPs who delegate management to another entity should still include the investments made by that delegate (on the basis that the FMP retains primary responsibility for the product/investments). While this response was expected, this clarification at a late stage prior to PAI reporting coming into effect could be unhelpful for some FMPs who use delegates (particularly third party ones) and have not put in place the infrastructure to feed those delegate’s investments into their own disclosures.
Scope of PAI disclosures: Qs19-21 are somewhat confusingly phrased, but seem to support the guidance in relation to the meaning of “all investments” discussed above, i.e. that FMPs should generally be disclosing PAIs in relation to their activities as an FMP rather than covering all “investments” or “investments decisions” (e.g. those made on own account by banks).
Financial product disclosures
Section III of the ESAs’ new Q&As give guidance on firms’ disclosures under the Level 2 SFDR RTS. The more notable clarifications concern:
Removal of sections: The ESAs say that sections can be removed from pre-contractual and periodic disclosure templates only where indicated by a red text instruction, e.g. confirming that questions on sustainable investments can be removed from Art. 8 disclosure templates where there will no commitment to make sustainable investments (Q1).
Good governance: The ESAs provide flexible guidance that use of reference metrics such as the UN Global Compact, OECD or ILO principles is not prescribed, but could form part of the good governance assessment (Q3).
Art. 6 products that do not consider ESG risks: The ESAs reiterate that in the “unlikely situation” a product does not consider ESG risks, an explanation must be given for why the FMP/financial adviser does not consider those risks relevant (Q4).
Consistency of socially sustainable investment assessment: Though confirming that it is possible for FMPs to create their own sustainable investment frameworks for their products, the ESAs go on to say that FMPs should not interpret Art. 2(17) SFDR (i.e. the sustainable investment definition) differently for different financial products it makes available. It is not clear whether the ESAs mean that exactly the same criteria to identify sustainable investments (which are not expressly specified in the definition) should be applied across all financial products (e.g. the same standards applied to emerging and developed investments), or more broadly whether the same overarching framework should be applied across an FMP’s product range. As the guidance refers to a consistent “interpretation” (rather than a consistent framework), we think the better view is that as long as the FMP is following the SFDR test consistently (e.g. assessing investments across all three limbs of the sustainable investment test i.e. positive E/S contribution, DNSH and good governance), then the requirement should be met.
In Section IV of its Q&A, the ESA address a number of questions on how SFDR Level 2 disclosures should be approach for multi-option products (“MOPs”). These Q&As deal with issues including the use of hyperlinks, periodic disclosures where certain investment options were not invested in during the whole reporting period, and MOPs that comprise a single investment option that (partially) invests in Taxonomy-aligned activities.
Taxonomy-aligned investment disclosures
Section V of the Q&A addresses questions around disclosures on Taxonomy-alignment. Key points to note include:
Taxonomy and PAI calculations: The ESAs give guidance on calculating taxonomy-aligned activities and PAI impacts, including clarifying that some PAI indicators “could be” applied at project level rather than company level where the investment is in a security that finances a specific project.
Article 8 products: Article 8 products that do not commit to making sustainable investments can leave out disclosure of sustainable investments during the reference period from their periodic disclosures.
Article 9 products: The DNSH related requirements under SFDR need to be applied to all sustainable investments, meaning that where an Article 9 product is partly taxonomy-aligned, the DNSH requirements also need to be applied to the taxonomy-aligned activities.
Optional third party review: The ESAs clarified that third party review of compliance of investments with the requirements in Article 3 of the Taxonomy Regulation is optional.
Pre-contractual disclosures v periodic disclosures: Pre-contractual disclosures should only include the minimum proportion of Taxonomy-alignment which the financial product commits to meet whereas actual achieved level of Taxonomy-aligned investments should be reported in periodic disclosures.
Activities with multiple objectives: Where an investment contributes to multiple objectives, it should nonetheless be counted only as contributing to one objective and the FMP should generally choose the objective to which the activity contributes most.
The ESA’s responses in this section also provided some guidance around the term “equivalent information” in Article 17(2)(b) of the SFDR RTS, as well as acknowledging the challenge posed by lack of data in the ESG space.
Some of the guidance raises potential uncertainties, for example the Q&A includes a table providing additional guidance on Taxonomy-alignment disclosure in both PCDs and periodic disclosures for Article 8 products. This appears to partially contradict previous Commission guidance as it states that in various cases disclosures of actual investments will need to be made where Commission guidance indicates funds could otherwise have just stated 0% Taxonomy alignment.
Financial advisers and execution-only FMPs
Section VI of the Q&A addresses questions on financial advisers, clarifying that the rules for financial advisers do not apply unless the financial adviser in question is giving advice.