The questions and answers (‘Q&A’), published by ESMA on July 26, were annexed to a Decision issued by the European Commission (EC) on July 6 and aimed at providing guidance on the application of Regulation (EU) 2019/2088 (sustainability related disclosures in the financial services sector) in a number of areas following questions raised by the European Supervisory Authorities (ESAs) (i.e. ESMA, EBA and EIOPA) in January of this year.
Key takeaways for financial market participants (FMPs) are:
The Sustainable Finance Disclosure Regulation (SFDR) applies to non-EU AIFMs that market their funds in the EU by means of a National Private Placement Regime.
SFDR applies to registered or sub-threshold AIFMs with the requirement for the latter to comply, ‘by analogy’ with the requirements to include certain information in pre-contractual and periodic documentation made available to end investors under national law, although registered AIFMs are normally not subject to such obligations under AIFMD and SFDR.
PAI and the 500-employee threshold requirement
The ‘comply or explain mechanism’ which distinguishes between ‘principal adverse impacts’ (PAI) and ‘adverse impacts’ is to be understood as follows: where FMPs decide not to apply the ‘comply mechanism’ by considering the ‘principal adverse impact’ they must ‘explain’ clearly the reasons why they do not consider ‘adverse impacts’ of investment decisions on sustainability factors.
500 employee criteria and groups: For FMPs to determine whether they can opt out of the ‘principal adverse regime’, the calculation of the headcount must include the number of employees of a parent undertaking and of subsidiary undertakings that are established in or outside the Union. The disclosure obligations will apply only at the entity level and not the group level.
Financial products subject to Article 9: These products can only invest in underlying assets qualified as ‘sustainable investments’ and also include investments for ‘certain specific purposes such as hedging or liquidity’. The Commission noted that Article 9 (and 8) is neutral in terms of product design, investment tools, strategies or methodologies, nevertheless, the product documentation must include information on how these elements complies with its ‘sustainable investment’ objective.
Financial products subject to Article 8: These products promote environmental or social characteristics. Clarification by the Commission includes:
A product name is sufficient to trigger the application of Article 8.
Article 8 products are subject to disclosure requirements.
The products may pursue reduction of negative externalities caused by the underlying investments, such as principal adverse impacts on sustainability factors.
They can partially be invested in ‘sustainable investments'.
Integration of sustainability risks (cf. Article 2 (22) of SFDR) is not sufficient for Article 8 to apply.
Are subject to Article 8 those products that comply with certain international environmental, social or sustainability requirements or restrictions provided that these characteristics are promoted in the product investment policy.
A broad explanation of the term ‘promotion’ that leaves room for interpretation and includes direct or indirect claims information, reporting, disclosures and other impressions that investments pursued by a given product also consider environmental or social characteristics. Impressions may include such documents as: (i) pre-contractual, and (ii) periodic documents, (iii) marketing communications, (iv) advertisements, (v) product categorization, (vi) description of investment strategies or asset allocation, (vii) information on the adherence to sustainability-related financial product standards and labels, (viii) use of product names or designations, (ix) memoranda or issuing documents, (x) factsheets, (xi) specifications about conditions for automatic enrolment or compliance with sectoral exclusions or statutory requirements. All this applies regardless of the form used (paper, durable media, websites, or electronic data rooms).
SDFR came into force on March 10, 2021 and required asset managers operating in the EU to categorize their products as:
‘Non-green’ or’ Grey’ (Article 6): Products that either consider ESG risks as part of the investment process, or are explicitly labelled as non-sustainable.
‘Light green’ (Article 8): Products promoting environmental or social characteristics, but not sustainability.
‘Dark green’ (Article 9): Products with a sustainable investment strategy.
The categorization purpose is to help entities determine the level of disclosure related to the various sustainability risks associated with their investments and products that they will be subject to.
Although, the Commission attempts for clarification fails as it did not provide enough comfort on how to efficiently and accurately achieve this product categorization.
The Commission's answers will be of particular interest to asset managers established outside of the European Economic Area (EEA), firms subject to Article 8 vs. Article 9 product categorizations.
To note that the delegated acts prepared under the SFDR will now not apply until 1 July 2022.