New parameters on use of estimations to inform SFDR disclosures need to be explained.
The European Commission’s latest clarifications on taxonomy-alignment disclosure rules under the Sustainable Finance Disclosure Regulation (SFDR) are “painful” and require further explanation, according to legal and industry experts speaking to ESG Investor.
In the Q&A document, the Commission has attempted to outline the importance of credible and reliable data to underpin asset managers’ disclosures on the environmentally sustainable investments made by their funds under SFDR, but has ultimately raised more questions than answers.
SFDR Level 1, which went live in March 2021, asks asset managers to sort their EU-domiciled funds into progressively greener categories: Article 6, 8 or 9. For the second part of the regulation, which comes into force in January 2023, the much-delayed regulatory technical standards (RTSs) were adopted by the Commission on 6 April. These will require asset managers to justify their fund categorisations through a series of environmental and social principal adverse impact (PAI) disclosures.
As part of their precontractual SFDR disclosures, asset managers are required to indicate whether, and to what extent, any investments made by their Article 8 or 9 products are aligned with the technical screening criteria of the Taxonomy Regulation, which outlines industries and activities across six environmental objectives that are considered sustainable and therefore suitable for investment via ESG-labelled fund solutions.
Earlier this month, the European Supervisory Authorities (ESAs) asked the Commission to clarify whether Article 8 or 9 products that promote other environmental or social characteristics and objectives, but haven’t “committed” in their precontractual disclosures to investing in any of the taxonomy’s specifically listed environmentally sustainable economic activities, are required to disclose “if it is determined later that the same financial product in fact invested in such economic activities”.
In response, the Commission has said that asset managers will be required to carry out assessments of their Article 8 and 9 funds, and, if taxonomy-alignment is subsequently identified where it wasn’t previously reported, they must amend their precontractual disclosures accordingly.
The Commission went one step further, however, noting that they may only disclose information on their funds’ degree of taxonomy-alignment if “they have reliable data”. Otherwise, the asset manager must indicate that the fund has “zero alignment”.
“This is painful and unhelpful because it seems to impose unrealistically high standards for data and its accuracy – but wholly accurate data just doesn’t exist right now,” said Raza Naeem, Counsel at law firm Linklaters.
The Commission added that in “exceptional cases” where credible data cannot be reasonably obtained to reliably determine taxonomy-alignment, asset managers are allowed to make “complementary assessments and estimates”.
It is unclear what would constitute an exceptional case.
“On the one hand, we can see how this will be a relief for [asset managers] concerned about liability and misrepresenting their degree of alignment,” said Hugo Gallagher, Senior Policy Officer at the European Sustainable Investment Forum (Eurosif).
“On the other hand, a number of financial products may actually have a certain degree of taxonomy-alignment – even if it’s very low – but may not have confidence in the data, and so indicating zero would also be misleading and therefore won’t fully represent the characteristics of the investment product.”
Both Gallagher and Naeem expect that asset managers will choose to err on the side of caution and avoid producing estimates, instead disclosing zero alignment and potentially hurting their commercial prospects.
“Estimates by their nature are always going to be somewhat unreliable and there is going to be a margin of error,” Gallagher added.
Philip Spyropoulos, Partner at law firm Eversheds Sutherland, noted that, while the Q&A document does provide some additional clarity, there are plenty of questions remaining ahead of Level 2 going live in January.
“There are still unknowns about SFDR that firms may not want answered now that we’re so close to implementation, because firms have already had to decide what they think these uncertain terms mean and have implemented their decisions accordingly,” he said.
To reflect the Commission’s decision to include nuclear energy and gas in the environmental taxonomy, the ESAs have also been tasked with making further amendments to SFDR’s RTSs.
This is to ensure that “investors receive information reflecting the provisions set out in the Complementary Climate Delegated Regulation”, the Commission noted in a letter to the ESAs in April.
The ESAs now have until 20 September to submit proposed amendments to the existing taxonomy-focused RTSs “in relation to the information that should be provided in precontractual documents, on websites, and in periodic reports about the exposure of financial products to investments in fossil gas and nuclear energy activities”.
This week, the European Securities and Markets Authority (ESMA) also published a briefing to both ensure convergence across the European Union in the supervision of investment funds with sustainability features and to better combat greenwashing in investment funds.
“The content of this briefing is not exhaustive and does not constitute new policy. It has been designed to be used in the way that best fits with supervisors’ methodologies, and may be updated to reflect regulatory developments or supervisory experiences,” ESMA said.