European Commission answers questions on SFDR

The European Commission published on May 252022 the answers to ESAs’ questions on the Sustainable Finance Disclosure Regulation ((EU) 2019/2088) (SFDR) and the Taxonomy Regulation ((EU) 2020/852). The paper covers details about topics such as PASI Statement, financial advisers and their recommendations of financial products, good governance practices for the investments of Art 8 and Art 9 products, and others.

The first question raised by the ESAs is about the PASI (Principal Adverse Sustainability Impact) Statement on entity level. The European Commission gives a clear answer that an FMP that is below the thresholds to disclose PAIs on an entity level, does not consider any PAIs and publishes a clear explanation on their website why they do not consider those, however, may manufacture a PASI and thus show that they pursue a reduction of negative externalities caused by the investments underlying that product.

Further clarifications are that FMPs must include the information in their PASI Statement setting out clear reasons as to whether and when they intend to consider such adverse impacts at entity level. A financial product pursuing a reduction of negative externalities caused by the investment underlying of that product must not be part of such entity level information.

On a product level, however, FMPs must assess whether a financial product falls under Article 8 or Article 9 product SFDR and prepare the respective pre-contractual and periodic disclosures according to Art. 6 and Art 11 SFDR, including information explaining how the products considers or has considered the financial product’s principal adverse impacts on sustainability factors.

Questions 2-4 are about financial advisers and their recommendations of financial products. The European Commission refers to the definition of investment advice as set in Article 4(1), point (4), of Directive 2014/65/EU: ‘the provision of personal recommendations to a client, either upon its request or at the initiative of the investment firm, in respect of one or more transactions relating to financial instruments.

The Commission makes clear that in SFDR investment advice is not restricted to financial products as defined in Article 2, point (12) SFDR. This means that financial advisers, when providing MiFID II investment advice, have to comply with disclosure obligations in Article 6(2) of Regulation (EU) 2019/2088 in good time before the client is bound by any agreement for the provision of investment advice “as a whole” even if they recommend non-Art. 8 and 9 products.

Additionally, all the obligations laid down in Articles 3, 4, 5, 6, 13 are not restricted to ‘financial products’ and cover products which are not in scope for SFDR i.e. shares of listed companies, corporate bonds, etc.

Question number 5 is about Article 17, SFDR, which exempts insurance intermediaries that provide insurance advice on insurance-based investment products (IBIPs) and investment firms which provide investment advice that are enterprises irrespective of their legal form, including natural persons and self-employed persons, provided that they employ fewer than three persons. As there is no definition of “employ” or “employee” in the Regulation (EU) 2019/208 the European Commission makes it clear that Article 17 applies regardless of the features of the employment relationship, i.e. part or full-time.

Another question, which has been intensively discussed in the industry, refers to already existing (as of March 102021) financial products: do these financial products need all the product disclosures according to SFDR – pre-contractual, periodic and website disclosures? The European Commission makes it clear that SFDR does not provide “any specific transitional legal regime concerning financial products made available to end investors before 10 March 2021 that continue to be made available to end investors after that date”. Hence, the regulation applies to already existing products as well and therefore all SFDR obligations have to meet for these products too.

For the case that a financial product is no longer made available to end investors and an FMP creates a periodic report as referred to in Article 11(2) SFDR after that date, the periodic report must comply with the requirements laid down in Article 11(1) of that Regulation.

The next question covers the topic good governance of underlying investments, where the European Commission make it clear:

• If a financial product referred to in Article 8 SFDR invests in companies, these companies must follow good governance practices. If this is not the case, then the financial product is in breach of Article 8 SFDR.
• If a financial product referred to in Article 9 SFDR invests in underlying assets, these underlying assets must qualify as ‘sustainable investments’, as defined in Article 2, point (17), of that Regulation, where it is required that the investee companies follow good governance practices, in particular with respect to sound management structures, employee relations, remuneration of staff and tax compliance. If this is not the case, then the financial product is in breach of Article 9 SFDR.

In the next question, it is clarified that good governance referred to in Article 2, point (17), and Article 8(1) SFDR relates to investee companies and companies and do not apply to government bonds. Hence, an Art. 8 product investing only in government bonds does not need to apply the requirements related to good governance practices referred to in the previous sentence.

The last question covers SFDR in connection with the Taxonomy Regulation (EU 2020/852), esp. Art 5 and Art 6 TR. Articles 5 and 6 TR apply in respect of the environmental objectives referred to in Article 9, points (a) and (b), of that Regulation from 1 January 2022 and in respect of the remaining environmental objectives referred to in Article 9, points (c) to (f), of that Regulation from 1 January 2023.

Neither SFDR nor the TR oblige FMPs that manufacture Art 8 or Art 9 financial products to invest in economic activities that qualify as environmentally sustainable under Article 3 of TR. The disclosure rules according to Art 5 and Art 6 TR  “aim to avoid harming end investor interest and to enable end investors to understand the degree of environmental sustainability of the investment whole value chain, including delivery of sound information on sustainability performance on underlying investments”.

In terms of data use, the European Commission makes it clear that FMPs may only disclose information on environmental objectives for the purposes of disclosures under Articles 5 and 6 of TR for which they have reliable data, otherwise they would risk, where relevant, infringing SFDR and TR.

Hence, where a financial market participant fails to collect data on the environmental objective or objectives set out in Article 9 SFDR and on how and to what extent the investments underlying the financial product are in economic activities that qualify as environmentally sustainable under Article 3 of that Regulation by a given financial product, the pre-contractual and periodic product related disclosures must indicate zero alignment. Should financial market participants decide to use narrative explanations on lack of reliable data, such narratives risk contradicting the purpose of Articles 5 and 6 of TR.

Our Regulatory Watch team is closely monitoring the final development of SFDR and Taxonomy requirements before the regulatory GoLive of Level 2 requirements on January 1st 2023.  cleversoft offers standardized services on the full range of relevant SFDR disclosure requirements. Benefit from our SFDR service with the different modules for your pre-contractual, periodic, web disclosure and PASI statement. We also offer modules covering the generation and collection of EET files. As part of our compliance commitment towards our clients, we provide regulatory updates in due time.

If you have any questions, feel free to contact us: our experts will gladly advise you on the details.