Introduction
The European Union wants to achieve net-zero CO2 emissions by 2050 – among other things with the Sustainable Finance Disclosure Regulation (SFDR). Since 2021, the regulation has required financial market participants and financial advisors to disclose information on investments in sustainable activities. The aim is to realign capital flows towards sustainable investments by incorporating sustainability into risk management and promoting transparency.
On December 4, 2023, the European Supervisory Authorities (ESAs) published a final report with proposals to amend the regulatory technical standards on SFDR.
The proposed changes relate in particular to the Principal Adverse Impact (PAI) indicators, the product disclosures on the targeted reduction of greenhouse gas emissions and the disclosure requirements for multi-option products (MOP). In addition, the disclosure templates will be adapted to improve clarity and, in particular, a summary dashboard will be introduced.
The main changes in detail:
1. New social PAI indicators
The proposed changes to the PAI indicators include three new mandatory social indicators for investments in companies, namely:
a) Amount of accumulated profits in non-cooperative tax jurisdictions,
b) Involvement in companies active in tobacco cultivation and production,
c) Percentage of employees receiving less than the appropriate wage.
The much-discussed fourth new mandatory social indicator “interference in the formation of trade unions or in the election of employee representatives” was converted into an optional PAI indicator and changed to “low collective bargaining coverage”.
2. Changes to the PAI framework
The calculation metrics of the PAI indicators for negative environmental impacts “CO2 footprint” and “greenhouse gas intensity of investees” will also be adjusted: Previously, there was no uniform basis for calculation, meaning that financial market participants were effectively free to choose how to calculate these indicators. In future, the ratio of the total relevant emissions per million euros invested will be used.
Financial market participants should disclose how much of the negative impact is based on data from the invested company and how much is based on estimates or reasonable assumptions.
Existing formulae will be adapted accordingly to ensure consistency with the adjusted indicators. For example, the greenhouse gas intensity of a country – in line with the Partnership for Carbon Accounting Financials (PCAF) standard – should be calculated using the adjusted gross domestic product with a purchasing power parity factor.
In order to remove previous uncertainties as to how certain investments should be treated for PAI disclosure purposes, derivatives shall be converted into economic exposure.
Value chains of investee companies should only be included in the PAI calculations if the investee company itself reports on this value chain.
3. Design options for the do no significant harm (DNSH) disclosure
Thresholds or criteria used to determine compliance with the DNSH principle should be disclosed on the website.
4. Disclosure of targets for reducing greenhouse gas emissions
New disclosure requirements should also be introduced for greenhouse gas emission reduction targets: These will be set on the basis of all relevant investments, with baseline measurement and progress monitoring on the same basis.
For reasons of comparability, the investments should include the following asset classes: listed equity and corporate bonds, sovereign bonds, business loans and unlisted equity, project finance, commercial real estate, mortgages and motor vehicle loans. The inclusion of other asset classes is possible if the investments are considered relevant – the financial market participant should then disclose the standard or methodology used.
In the future, investments in sovereign bonds will have to be disclosed separately to improve comparability between products with different asset bases.
To avoid overburdening retail investors with technical information, aggregated data for all asset classes except sovereign bonds should be required for disclosure in pre-contractual documents and periodic reports.
Financial market participants should transparently disclose on the website the proportion of investments for which the gross greenhouse gas emissions were reported by, obtained from, or estimated from the companies in which the investments are made.
In the context of Assets under Management (AuM)- and Enterprise Value Including Cash (EVIC)- based calculation metrics, it is proposed that financial market participants must disclose unadjusted metrics as part of their pre-contractual documents and periodic reports. To reduce market-driven volatility in results, disclosure of the adjusted metrics, together with the adjustment factor used and an explanation of how it was constructed and applied, should be also permitted as part of the disclosure on the website.
Financed greenhouse gas emissions at the product level should only reflect gross greenhouse gas emissions. Greenhouse gas emission reduction targets for financial products should also be set on this basis. The removal and storage of greenhouse gases, carbon credits or avoided emissions generated by the invested companies or the financed projects cannot be used as a means to achieve greenhouse gas emission reduction targets. In addition, financial market participants cannot purchase carbon credits or rely on the calculation of avoided emissions to achieve greenhouse gas reduction targets at product level.
Recognising the potential contribution of carbon credits to climate change mitigation however, financial market participants should be able to disclose in their periodic reports the quantity of carbon credits that they have purchased or cancelled during the reporting period – but this should be separate from the monitoring of progress towards the financed greenhouse gas emission reduction targets financed. In this case, detailed information is required on the website, with the cancelled credits disclosed only in relation to a single financial product and the investor being informed about the quality of these carbon credits. The share of the carbon credits that have been certified by recognised quality standards for carbon credits (as defined under Annex 2 of the European Sustainability Reporting Standards (ESRS)) must be disclosed.
5. Disclosure for financial products with investment options
For multi-option products (MOPs), enhanced disclosure should be provided in the pre-contractual documents in the form of a “dashboard” containing key information on the investment options. In principle, disclosure should be provided for each investment option separately, regardless of its status as a financial product under the SFDR; in cases where the number of underlying options prevents clear and unambiguous disclosure, periodic disclosures may be provided through a hyperlink to the relevant sectoral SFDR disclosure.
The information on the website for the MOPs referred to in Art. 8 (1) or Art. 9 (1) to (3) SFDR should include the following information:
a) a dashboard that summarizes the key sustainability-related information on the investment products that qualify the financial product as such under Art. 8 or 9 SFDR; and
b) the disclosure of additional details at the level of individual investment options; where appropriate, the information may be provided through a hyperlink to the specific section on the website of the relevant investment option, where the hyperlink may be a direct link to the relevant SFDR disclosure for the specific investment option.
6. Simplification of the templates, introduction of a dashboard
The templates will be simplified by reorganizing the information provided and removing the green colouring of all input fields except the taxonomy diagrams. To make the disclosure more understandable and less complex, a special dashboard is proposed, with the most important information on the first page of the documents, and the detailed information on the following pages. The dashboard indicates whether a financial product has a sustainable investment objective or promotes environmental/social objectives and contains four main key elements: i) sustainable investments, ii) taxonomy-aligned investments, iii) consideration of key PAIs and iv) greenhouse gas emission reduction targets. Icons have been added to indicate whether the product contains any of these elements.
The summary information on the website must include the dashboard, which is the first page of the pre-contractual information.
7. Other changes
a) Calculating proportion of sustainable investments
The proposed amendments include a new Art. 17a, which provides two options for calculating the proportion of sustainable investments of financial products: the numerator can be calculated on the basis of the individual economic activities of the portfolio companies or on the basis of investments in whole companies. In any case, the denominator is the market value of all investments.
Financial products must disclose in the pre-contractual information on the website and in the periodic disclosure which of the two methods they have chosen to calculate their sustainable investments.
b) Readability
As the future disclosures via the European Single Access Point (ESAP) should be made in a format that can be read by both humans and machines, all SFDR disclosures should therefore fulfil this requirement. The ESAs recommend the XBRL format.
What happens next?
The European Commission will decide on the approval of the proposed amendments to the RTS within three months. The amended RTS will then enter into force on the twentieth day following their publication in the Official Journal of the European Union. It is not yet known when they will apply. The original version of the RTS provided for a transitional period of approximately 8 months after entry into force, while the amending regulation (Delegated Regulation (EU) 2023/363), issued on the basis of the fossil fuels and nuclear energy amendments, did not provide for a transitional period and the regulation entered into force – contrary to the usual practice – only three days after publication. As the new RTS will likely involve a significant number of changes, which not only grant options but also introduce new obligations, we believe that a transition period of at least several months will be necessary.
