European Commission solicits views on how to improve the Sustainable Finance Disclosure Regulation (SFDR)

The European Commission has now released its consultation on the implementation of the Sustainable Finance Disclosure Regulation.   As expected, the Commission is interested in understanding how the SFDR has been implemented and any potential shortcomings, including in its interaction with other parts of the European sustainable finance framework. 

Whilst the consultation has been issued as two papers;

• The first paper is a public consultation aimed at those individuals and organisations with only a general knowledge of SFDR.  The paper focuses only on the current requirements of the SFDR and its interaction with other sustainable finance legislation.
• The second paper is a “targeted consultation” aiming to gather feedback from those public bodies and stakeholders who are more familiar with the SFDR and the EU’s sustainable finance framework as a whole.  This targeted CP duplicates each of the questions in the public CP but then goes on in parts 3 and 4 to pose a series of more detailed questions on potential changes to the disclosure requirements for financial market participants and the potential establishment of a labelling system for financial products. 

Rather than setting out detailed proposals at this stage, the CP instead poses a series of questions seeking views on the existing framework, and potential changes.  No doubt once the Commission has had an opportunity to digest any responses and develop its thinking based on that input, a more fulsome set of proposals will be forthcoming.

Respondents have until 15^th December 2023 to provide their input, and in order to kickstart this process, the Commission will, on 10^th October, hold an online workshop to discuss current challenges of the SFDR and possible ways forward for sustainability disclosures in the EU.   It is expected that this will be followed by further workshops and roundtables, enabling stakeholders to submit further input. 

Key points to note

The CP asks questions in the following key areas:

Potential changes to the disclosure requirements for financial market participants

• Potential removal of entity-level disclosures under SFDR: The CP asks whether SFDR is the “right place to include entity level disclosures” and if there is “room for streamlining sustainability-related entity level requirements across different pieces of legislation” in the context of other EU legislation requiring entity level disclosures, such as the CSRD and the CRR. This question potentially hints that the Commission is considering removing/reducing the entity level disclosures required under SFDR, given that many asset managers and financial advisers will soon be required to provide ESG disclosures under separate pieces of EU legislation (and AUM may be captured as part of the “value chain” disclosures under CSRD, depending on the final sector-specific ESRS for the finance sector). In particular, the CP asks which PAI indicators are the most and least useful, so the Commission may be considering removing some of the less useful PAIs.
• Interaction of product categories with current disclosure regime: As had been expected, the Commission is interested in whether there is “a demand for establishing sustainability product categories” – although the CP does state that it does not pre-empt any decisions about how the proposed categorisations would interact with the current disclosure regime. It may therefore be the case that the current disclosure regime (with some enhancements) operates in parallel to a new product categorisation regime, with certain disclosures only being required for certain product categories.
• Additional uniform sustainability disclosure requirements for all funds: The CP states that SFDR may place an additional burden on products with sustainability considerations (since they have to meet the SFDR reporting requirements) versus those without any sustainability commitments. Therefore, the CP asks whether uniform disclosure requirements (such as disclosures on certain PAI indicators, engagement strategies and exclusions) should be introduced for all products, including products without any sustainability claims. This would mean that Article 6 products (without any binding E/S commitments) would have to provide information on their sustainability performance/features. While this may allow funds which don’t have any ESG commitments to still provide information to investors on how ESG their investments actually are (e.g., through periodic reporting), it would also impose additional obligations with which asset managers would be required to comply, and Article 6 funds may very well need to answer “not applicable” to a lot of the ESG disclosure requirements.
• Additional SFDR disclosures and lighter SFDR disclosures for certain investments: The CP includes questions asking about additional disclosures that could be required under SFDR, including Taxonomy-related disclosures, engagement strategies, exclusions and information about how ESG-related information is used in the investment process. We may therefore expect that the final Commission proposal will contain amendments to the current information required to be disclosed under SFDR. There are also questions relating to whether the required disclosures should be dependent on the type of product/investment (e.g., if the underlying investments are in SMEs/outside the EU), which could indicate some disclosure requirements may be eased for certain products/investments.
• Amendments to current breakdown of SFDR information: The CP asks various questions about the current breakdown of information between SFDR pre-contractual disclosures, periodic disclosures and website disclosures. The questions generally indicate that the Commission is thinking about whether this breakdown of information, the levels of detail in the disclosures and the locations of the disclosures are helpful for investors, so we may see changes in this space.
• Product level versus entity level disclosures: The CP asks whether product level disclosures should be independent from entity level disclosures. Currently, many in the market take the view that a fund could consider PAIs/sustainability considerations, even if the asset manager of the fund does not consider PAIs – however the CP hints that the Commission are re-considering this view, which would be an unhelpful development if products can only be considered “sustainable” if the entity itself is “sustainable”.
• Sustainability scale in product-level disclosures: The CP asks whether it would be useful if product-level disclosures were expressed on a scale. While they do not set out what this scale could be, this may be similar to the PRIIPs risk scale – so asset managers would have to rate their products on a scale of 1-7 on how “green” they are. This may be helpful with assisting retail investors to understand how sustainable products are – although it is unclear how an “ESG scale” could be defined so that it captures the wide variety of ESG products sensibly.
• Accessibility of SFDR disclosures: The CP contains various questions about the need to improve the accessibility of SFDR information in a digital context (e.g., whether the SFDR information should be machine readable, interactive or available in the upcoming ESAP). If implemented, these changes may pose additional operational difficulties for firms.

Potential establishment of a categorisation system for financial products

• Product categorisation: As anticipated, the CP is seeking to address the fact that Article 8 and 9 of SFDR are being used as de facto labels – despite this not being the original intention.   The CP is therefore seeking views about the “merits of developing a more precise EU-level product categorisation system based on precise criteria”, and the governance arrangements that such a system might warrant (the CP poses questions around third party verification versus self declaration).  Two approaches for product categorisation are posed:
  • One approach builds on the existing approach: converting Articles 8 and 9 into formal product categories, and clarifying and adding criteria to underpin the existing concepts of environmental/social characteristics, sustainable investment and DNSH.  
  • The second approach suggests splitting categories in a different way: for example, perhaps focusing on the type of investment strategy of the product – in such a scenario, concepts such as environmental/social characteristics or sustainable investment and the distinction between current Article 8 and 9 of SFDR may disappear entirely from the transparency framework.  Under this proposed categorisation system, the Commission sets out descriptions of four categories (and an option for respondents to suggest their own).  Three of these broadly correspond to the labels set out by the FCA in its proposals for the forthcoming SDR regime.  The fourth covers funds that exclude activities/investees involved in activities with negative effects on people and/or the planet (the FCA had proposed a similar label in an earlier CP – which was subsequently dropped in its second CP).  No doubt as the Commission develops its thinking in this area, it will be watching closely and learning from the experience of the FCA under the SDRs.
• Product Names: it is clear from the CP that the Commission is giving thought to the potential for fund names, and marketing communications to mislead clients and other stakeholders, and the manner in which such specific rules should be set out in the SFDR.  The questions posed hint that the Commission may potentially tie the use of certain terms to certain product categories – or prohibit their use for products that do not fall under at least one product category.

Current requirements of the SFDR 

Some very broad questions are put to stakeholders around the effectiveness of the existing regime.

• How the SFDR works in practice:  the CP requests views on whether the SFDR’s broad objective of strengthening transparency through sustainability related disclosures remains relevant.  It also drills down into the effectiveness of the rules in achieving the more specific stated objectives.  The Commission is also interested in understanding the areas in which entities are facing challenges in obtaining good quality data.  A number of the questions also focus on the use of estimates – how far the regime allows for their use, the clarity of the rules in this area, and the types of estimates that entities use in practice to fill their data gaps. 
• Costs of compliance: the Commission is interested in whether the costs of disclosure under the SFDR are proportionate to the benefits that the framework generates.  This appears to be driving at the Commissions considerations of the impact of the regime, and the costs incurred in compliance, on the competitiveness of the EU globally.  There is opportunity to provide estimates of one off and recurring annual costs, the split between the costs of product level and entity level disclosures, and details of the number of employees involved in preparing SFDR disclosures. 

Interaction with other sustainable finance legislation

• Questions in this section centre on the current interactions between the SFDR and other parts of the EUs sustainable finance regime (for example the extent to which the product disclosures required under SFDR are sufficiently useful to enable financial advisors/distributors to conduct their suitability assessments under MiFID II/IDD), as well as potential inconsistencies or misalignments (and the extent to which existing guidance clarifies the issues).