ESAs have launched a public consultation on extension and simplification of disclosures under SFDR

The three European Supervisory Authorities (EBA, EIOPA and ESMA, ESAs) have published a Consultation Paper on 12 April 2023 in which they propose amendments to Commission Delegated Regulation (EU) 2022/1288 (SFDR RTS). The SFDR RTS implement the regulatory technical standards of Regulation (EU) 2019/2088 as amended (SFDR).

By way of background, the review conducted by the ESAs is based on a mandate the ESAs received from the European Commission (EC) on 28 April 2022 to review and revise the SFDR RTS. It is not to be confused with the broader review of the SFDR announced by the EC in January 2023. However, in their Consultation Paper, the ESAs did eventually go beyond the scope of their mandate to also address concerns financial market participants (FMPs) have raised regarding the current SFDR framework.  

Potential impact and next steps 

The proposal has no immediate impact. It is an extensive Consultation Paper merely containing proposals made by the ESAs. The deadline for feedback is 4 July 2023. Although the ESAs have not indicated when they expect to publish final rules, they informed the EC in October 2022 that they will deliver the Final Report under the mandate by the end of October 2023 after considering feedback from the public consultation and targeted consumer testing.

However, if the changes were to be adopted as proposed by the ESAs, the changes would be quite material and could impact the categorisation of certain Article 9 products (because of changes to the DNSH - Do Not Significantly Harm - test and PAI - Principal Adverse Impact - indicators), require updates to the existing PAI and product disclosures (due to the inclusion of additional PAI indicators and changes to the product templates) and require FMPs to provide detailed disclosures of any product level GHG emission targets. 

ESAs proposed changes 

The main proposals made by the ESAs concern:

  • Expanding the list of universal social indicators for disclosing the adverse impacts of investment decisions on the environment and society and refining the content and definitions of existing PAI indicators and calculation formulae;  
  • Proposed changes to the DNSH test; and
  • Adding product disclosures concerning decarbonisation targets.
1. Proposed changes regarding PAI indicators

a.    Universal Social Indicators 
The ESAs propose four (4) new universal social indicators for the disclosure of the principal adverse impacts of investment decisions on the environment and society. The proposed new mandatory social PAI indicators are:

  • Amount of accumulated earnings in non-cooperative tax jurisdictions for undertakings whose turnover exceeds €750 million;
  • Exposure to companies involved in the cultivation and production of tobacco;
  • Interference in the formation of trade unions or election of worker representatives; and
  • Share of employees earning less than the adequate wage.

FMPs are proposed to report on these new mandatory social indicators at entity level but also within their DNSH framework for sustainable investments on the product level (if applicable). 

The ESAs also propose opt-in social indicators, such as: 

  • Excessive use of temporary contract employees in investee companies;
  • Insufficient employment of persons with disabilities within the workforce; or
  • Lack of grievance/complaints handling mechanism for stakeholders/end-users affected by the operations of the investee companies;  

The ESAs have addressed specifically the question of real estate assets which currently have no social PAIs that apply to them. They ask feedback on how the rules should be amended to enable real estate investments to consider social factors.

b.    Changes to existing PAI indicators and calculation formulae
The ESAs are proposing to change several PAI indicators to better align with the reporting under European Sustainability Reporting Standards (ESRS). Some PAI indicators are also being amended to ensure consistency with Regulation (EU) 2020/852  (Taxonomy Regulation) and Regulation (EU) 2019/2089 (known as the Low Carbon Benchmark Regulation). This is the case for example of the new tobacco exposures social PAI indicator (in line with the exclusions under the Climate Benchmarks Delegated Regulation) and of the amendment to PAI 10 (Violations of UN Global Compact principles and Organisation for Economic Cooperation and Development (OECD) Guidelines for Multinational Enterprises) and 11 (Lack of processes and compliance mechanisms to monitor compliance with UN Global Compact principles and OECD Guidelines for Multinational Enterprises) to align these PAI indicators with the minimum social safeguards set our in the Taxonomy Regulation.

The ESAs also ask feedback on the “all investments” metric used in PAI calculations for different asset classes. It is unclear at this stage whether “all investments” should refer to all investments of the FMP or only investments that concern a specific class of assets (investee companies, sovereigns and supra-nationals or real estate assets). It appears from the Consultation Paper that currently the denominator in the PAI calculations would be all the investments of the FMP, and not just the investments in a specific asset class. However, this does not seem very clear under the current guidance and some further clarification would have been welcome. 

Finally, the ESAs also propose to disclose in the “explanation” column of the PAI disclosures, the proportion of data that is obtained directly from investee companies.  

 c.    Consideration of value chains in PAI disclosures
Currently, it is unclear whether the value chains of investee companies should be taken into account when calculating PAI indicators, except for Scope 3 GHG emissions-related PAI indicators. However, the ESAs are now proposing that the value chain contribution of investee companies should be considered if the investee company reports on its value chain impacts according to the ESRS under its own materiality assessment performed under the ESRS. In cases where the investee company does not report on value chain impacts, FMPs should include information on the value chains of investee companies where such information is readily available, such as in the public reporting of those investee companies. However, this could prove to be a significant challenge for FMPs, especially if the investee companies do not disclose this information under the ESRS.

d.    Treatment of derivatives in the PAI indicators
There have been a number of discussions with national competent authorities on the treatment of derivatives in the calculation of PAI indicators and on the fact that derivatives cannot be treated as making a positive contribution to “Taxonomy-alignment”. There is no clear guidance on how they should be treated under the SFDR sustainable investment test, or in the numerator of PAI calculations. The proposed solution would be to require the inclusion of any derivative with an equivalent long net exposure in the numerator of the PAI indicator, because in such cases the transaction would have resulted in money going towards the adverse impacts identified in the indicators. Where FMPs can show that this derivative does not ultimately result in a physical investment in the underlying security by the counterparty – or any other intermediary in the investment chain – the FMP would be allowed to consider that this derivative investment does not result in an adverse impact and should therefore be allowed to exclude it from the numerator. This would not affect the calculation of the denominator, which should always include all investments including derivatives. In most cases the counterparty with which an FMP conclude a derivative transaction hedges itself with short or long exposures on the same underlying assets, but such hedging is not automatic. Derivative exposures should not be treated as sustainable investments (mirroring the approach for Taxonomy-alignment) again if they amount to an equivalent long net exposure, and short positions (including via derivatives) should be used to reduce the long net exposure on a given Taxonomy-alignment / SFDR sustainable investment issuer. It seems that derivatives can have negative ESG impacts but not a positive one. In accordance with question 1.3 of the ESAs November 2022 Q&As, adverse impacts should be netted at the level of an individual counterparty without going below zero.

2. Proposed changes to the DNSH test for sustainable investments 


The ESAs are proposing changes to the DNSH test. One of the issues mentioned is the confusion created by the non-alignment of environmental PAIs in the DNSH test and the DNSH criteria in the Taxonomy Regulation. The ESAs also noted that a significant share of Article 9 SFDR financial products have exposures to fossil fuels, and, in particular, to coal activities. The ESAs note that the disconnect with the Taxonomy Regulation will only be resolved in time and that so far they prefer maintain the status quo – noting that the SFDR and EU Taxonomy (for climate change mitigation / adaptation) regimes have only just become fully applicable and further change at this stage could result in legal uncertainty. In the framework of the future reform of Level 1 SFDR, the Taxonomy DNSH criteria could form the basis of the SFDR DNSH assessment. The ESAs mention in the Consultation Paper that this would likely be a long-term consideration because the EU Taxonomy assessment is done at economic activity level, whereas the SFDR assessment must be done at the entity/investment level and is sector-agnostic.  There is no easy shift because of the inconsistency between the two systems. Another option that is envisaged is to provide an optional safe harbour for Taxonomy-aligned investments (such investments would be deemed to be sustainable investments under the SFDR. This was not considered feasible when it was proposed by the ESAs back in 2021. The ESAs also consider that the website disclosures of the financial product should set out quantitative DNSH thresholds for each PAI indicator.

3. Proposed changes to product level disclosures

a.    "Simplification" of product-level disclosure templates
The ESAs recognise that the current financial product disclosure templates are overly complicated and lengthy. In an effort to improve their comprehensibility, particularly for retail investors, the ESAs are proposing certain changes to the language, layout, and structure of these templates. This includes simplifying the phrasing of the questions across the templates and reducing the use of technical terms, making them more accessible and easier to understand for the general public. These changes aim to enhance the clarity and transparency of financial product disclosures while streamlining the reporting process for FMPs.

b.    GHG emissions reduction targets at product level 
The ESAs propose new disclosures in pre-contractual documents, on websites and in periodic reports on GHG emissions reduction (i.e. decarbonisation) targets.

  • In pre-contractual documents, simplified disclosures are meant to provide information on the type of outcome the product is committing to achieve, on the level of ambition of the target(s), in particular for products disclosing under Article 9 SFDR the alignment of the target with the goal of limiting global warming to 1.5 degree Celsius and on the share of investments covered by the target (if not covering all investments although the target needs to be calculated on the basis of all investment). Disclosures are also proposed to explain how the investment strategy will help deliver on the target(s). 
  • In the periodic reports, additional simplified disclosures are meant to provide information on progress to date and to explain how the investment strategy contributed to such progress. Periodic reports should also identify the potential delays in achieving the target(s) and potential adjustments needed.
  • A third set of disclosures, more detailed and available on the financial product’s website will complement pre-contractual and periodic disclosures. Cross-references to the website should be included in both the pre-contractual documents and the periodic disclosures. 

This does not appear to us as a simplification but to the contrary an additional complexity. 

c.    ‘Dashboard’ of key information 
The ESAs also propose a new approach to pre-contractual and periodic disclosure templates for financial products. They suggest replacing the existing summary box with a "dedicated dashboard" of key information. This is intended to draw the attention of retail investors to the most important information, without overwhelming them with excessive detail. 

The dashboard would include a concise narrative summary, limited to a maximum of 250 characters (including spaces), outlining the environmental and social characteristics of the product, along with the percentage of investments that promote these characteristics (for Art. 8 products) or the sustainable investment objective (for Art. 9 products). The dashboard would also require disclosure of the minimum commitment of sustainable and Taxonomy-aligned investments, whether or not the product considers PAIs (which is expected for Art. 9 products), and whether the product has a GHG emissions reduction target.

Using the dashboard may have the additional benefit of eliminating the need for an asset allocation diagram, as the dashboard would provide upfront information on the product's sustainable and Taxonomy-aligned investments. This answers the challenges faced by firms in determining the E/S split of investments in the current version of the template.

Simplification of SFDR framework should be a priority 

The proposed changes to the disclosure framework were made to address issues that have emerged since the introduction of SFDR. Simplifying the SFDR disclosure can increase transparency and comparability, allowing investors to make more informed decisions and better assess the sustainability performance of investment products. It can also help to promote the growth of sustainable finance by making it easier for investors to identify and invest in sustainable products. The lack of clarity of certain disclosure requirements is an additional issue.

For these reasons, in their review of the SFDR RTS, the ESAs have gone further than the explicit EC mandate and have proposed (i) changes on the existing disclosures of do not significantly harm - considered as leaving too much discretion to FMPs, (ii) some simplification of the current templates - often considered too complex and difficult to understand by retail investors, and (iii) a number of other technical adjustments meant to facilitate the use of the templates and the application of the standards.  

The disclosure requirements can be complex and challenging to understand, not only for FMPs and financial advisers but also for retail investors who may not have a background in finance or sustainability. If SFDR disclosures are not simplified, there are several risks that can arise such as:

  • Misunderstanding: The complexity of the SFDR disclosure requirements can make it difficult for investors to understand how sustainability risks are being managed and what the adverse sustainability impacts of investments are.
  • Inconsistency: The lack of standardisation and comparability in SFDR disclosures can lead to inconsistencies between different products and providers but also with other EU framework such as the Taxonomy Regulation. This can make it challenging for investors to compare and assess sustainability performance, which may limit their ability to identify sustainable investments and support the transition to a more sustainable economy.
  • Regulatory compliance: FMPs and financial advisers who fail to comply with SFDR disclosure requirements may face regulatory and reputational risks, which can result in financial penalties, legal actions, and damage to their reputation. Simplification of SFDR disclosures can help ensure that market participants are able to comply with SFDR.

A first reaction on the ESAs’ proposals

The proposals should be carefully examined and reviewed notably based on the feedback received during the public consultation. At first sight, in some areas, we fail to see simplification but rather a new layer of complexity. 
Also, the SFDR requires FMPs and financial advisers to disclose a significant amount of sustainability-related data. Such data may not always be readily available, particularly for smaller companies or those operating in less transparent industries which creates complexity at the level of the FMPs. This is unfortunately not addressed by the proposal. 
The EC adopts as guiding principle to reduce the risk of “false certainty” and greenwashing. However, the amended SFDR RTS should be carefully calibrated so that disclosures based on these indicators are proportionate and feasible for FMPs at the risk of excluding from the green transition a large number of market players.