European Disclosure Rules Too Open to Interpretation – Dechert

Global law firm Dechert backs SFDR Level 1 concerns raised by ESAs last month.

Many asset managers are struggling to meet new disclosure requirements for sustainable investment products, just over a month before they come into force, according to global law firm Dechert.

With Level 1 of the Sustainable Finance Disclosure Regulation (SFDR) scheduled to ‘go live’ on March 10 2021, Dechert has backed concerns raised by the European Supervisory Authorities (ESAs) to the European Commission (EC), citing the tight timeframe for implementation and an ongoing lack of clarity around requirements such as suitable labels for green products.

“The problem is that there are still lots of uncertainties as to what extent the rules would require the industry to disclose – many of the terms and concepts used in the regulation need to be further interpreted,” Angelo Lercara, Financial Services Partner at Dechert, told ESG Investor.

“Obviously, having this level of uncertainty can be uncomfortable when trying to implement changes and trying to meet regulators’ expectations.”

Last month, the ESAs – the European Banking Authority (EBA), European Insurance and Occupational Pensions Authority (EIOPA) and the European Securities and Markets Authority (ESMA) – sent an open letter to the European Commission, stating Level 1 “would benefit from a more urgent clarification to facilitate an orderly application of SFDR from March 10 2021”.

The ESAs called for further information on differentiating between adhering to Article 8 versus Article 9 of SFDR, as well as further clarity on how to apply SFDR product rules to MiFID portfolios and other tailored products.

Article 8 refers to ESG products that do not have sustainable investment as their main objective, whereas Article 9 refers to ESG products where the main focus is on sustainable investment, such as mitigating the risk of climate change. The supervisors also recommended a more comprehensive explanation of what the EC defines as “promotion” of products with environmental or social characteristics.

In particular, Lercara said further explanation was needed by managers on how SFDR Level 1 will relate “sub-threshold” funds regulated under the Alternative Investment Fund Managers Directive (AIFMD).

“These are the fund managers that manage funds whose assets under management are ‘sub-threshold’, which means that they do not meet certain size criteria and are therefore not subject to the full requirements of the AIFMD,” Lercara explained. “It is unclear whether the SFDR applies to those managers or not since they are not mentioned in the regulation.”

Simon Wright, Counsel at Dechert, added that the applicability of SFDR Level 1 for asset managers or fund managers that are not in the EU – particularly the UK – needs to be more clearly explained.

“There still isn’t legal certainty as to how these rules will apply for non-EU entities,” he said. “There are clearly market positions they can take, and most people have a fairly firm view as to how they will comply, but there are still outstanding legal issues which are being tested and raised directly to the EC as to whether – and how – SFDR applies to non-EU alternative investment fund managers.”

SFDR Level 2 delegated regulatory technical standards (RTS) have been consulted on by the ESAs, but are not yet finalised, having been delayed to a later stage.

“The questions raised by the ESAs, if answered, will provide financial market participants with much-needed guidance as to how to prepare for March 10 2021, although with the clock running down, answers would be welcomed sooner rather than later,” Dechert said in its recent blog post.

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