ESAs publish Last Minute Q&A on SFDR Delegated Regulation

The European Securities and Markets Authority (ESMA) published Questions and Answers (Q&A) on the SFDR Delegated Regulation RTS (Commission Delegated Regulation (EU) 2022/1288) on November 17 only 6 weeks before the Level 2 regulation comes into force.  

The Q&A clarifies a number of points including those relating to principal adverse impacts (PAI) and taxonomy-alignment in pre-contractual documents, website information and periodic reporting.

In this article you will find a summary of the main points affecting the SFDR Disclosures and how cleversoft will handle these.  

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Current value of all investments in PAI and Taxonomy-aligned disclosures

1. All investments

a. PAI: “all investments” should be understood to mean both direct and indirect investments funding investee companies or sovereigns through funds, funds of funds, bonds, equity instruments, derivative instruments, loans, deposits and cash or any other securities or financial contracts.

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The publication includes remarks for the specific use cases:

• Asset managers: For AIFM, managers of venture capital funds, managers of social entrepreneurship funds, management companies of UCITS, “all investments” should be considered the same as that Section 1.2 of Annex III of Regulation (EU) 2021/2178, i.e. all Assets under Management resulting from both collective and individual portfolio management activities;
• Insurers: “All investments” should include the following aggregates from the prudential balance sheet as defined in the Commission implementing regulation 2015/2452: holdings in related undertakings, equities, bonds, collective investment undertakings, derivatives, deposits other than cash equivalents, other investments, assets held for index-linked and unit-linked contracts, loans and mortgages and deposits to cedants and cash and equivalents
• Banks or investment firms providing portfolio management or investment advice services: “All Investments” should include all the securities and financial contracts (which should be considered to include cash and cash equivalents) held by credit institutions and investment firms as part of the mandates given by their clients as referred to in article 4 (1) point 8 of Directive 2014/65/EU.

>> cleversoft will adjust the calculations respectively to contain cash in the denominator as suggested by the regulator

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b. Taxonomy-alignment: in order to disclose “investments of the financial product in environmentally sustainable economic activities”, Article 17(1) of the Delegated Regulation sets out a closed list of investments that are “investments of the financial product in environmentally sustainable economic activities”.

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As written in the Q&A (page 5): This is not the same as the “net asset value” of a financial product. While the net asset value would be netted by the financial product’s liabilities, the market value of all investment is the sum of all assets held by the financial product. Using the net asset value would lead to a higher share of Taxonomy-aligned investments than using the sum of all investments and could theoretically even lead to a share higher than 100% if all assets are Taxonomy-aligned and the liabilities would be deducted in the denominator.

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2. Short positions

The principal adverse impacts of long and short positions should also be netted accordingly at the level of the individual counterpart (investee undertaking, sovereign, supranational, real estate asset), but without going below zero.

The calculations for short positions should apply the methodology used to calculate net short positions laid down in Article 3(4) and (5) of Regulation (EU) No 236/2012 of the European Parliament and of the Council.

>> cleversoft does already consider short positions.

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PAI Disclosures

1. Should financial market participants disclose what share of PAI impacts have been estimated and what have been calculated on the basis of reported information? It would be a good practice, but not obligatory, for financial market participants to include, where relevant for the PAI Disclosure:  ‍

а. The proportion of investments for which the financial market participant has relied on data obtained directly from investee companies, in order to calculate the corresponding indicator; and ‍

b. The proportion of investments for which the financial market participant has relied on data obtained by carrying out additional research, cooperating with third party data providers or external experts or making reasonable assumptions, in order to calculate the corresponding indicator.

>> cleversoft will include these two comments as long as this information is provided by the respective data provider, e.g. sustainalytics have an extra field for researched and reported data. The cleversoft system already provides a flag to turn on and off the usage of estimates and additional researched data.

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2. Clarifications on PAIs

In this table we have summarized all the PAIs with additional clarifications: both from the current Q&A and the clarification document from June 2022.

>> cleversoft ensures that the PAI calculations will keep considering all the above-mentioned clarifications.  

3. Further relevant points regarding PAIs

• When having the management of a portfolio fully or partially, the ESAs expect the PAI-disclosure to cover all investments of the product, irrespective of whether the investment management is delegated or not.
• For the PAI calculation in the PASI statement, where 4 data points in 31 March, 30 June, 30 September, and 31 December are required, the ESAs provide the clarifications that FMPs should calculate all the impacts from the four data points at the same time. Furthermore, the latest available information on the impacts of the investee companies should be used. In case information about the impacts of the investee companies is not publicly available, FMPs should use best efforts to complete the values for each indicator. This information is then obtained either directly from investee companies, or via additional research, cooperate with third party data providers or external experts. Reasonable assumptions are also possible. FMPs must then disclose how these efforts were made according to Article 7(2) in the appropriate field in the template provided in Annex I of the Delegated Regulation.

>> cleversoft is running all the necessary calculations for the four periods when generating the PASI statement considering the portfolio positions form each period.

• The timing of the amount of the current investments in an investee company (holding date) and the enterprise value (company’s fiscal year end) are not aligned in the delegated regulation. Given market movement between those dates, the calculation of the percentage owned will be inaccurate. Art 6 (3) states for the PAIs it is an average of the impacts on four dates, so this will lead to problems in some cases and will lead to over/under representation of the emissions of some investee companies. The ESAs are aware that there is a potential misalignment between the timing of the (at least) quarterly calculations of the adverse impacts. The quarterly impacts should be based on the current value of the investment derived from the valuation the individual investment (e.g. share) price valued at fiscal year-end multiplied by the quantity of investments (e.g. shares) held at the end of each quarter. In such manner the composition of the investments at the end of each quarter is taken into account, but the valuation reflects the fiscal-year end point in time.

>> cleversoft is already considering the current investments and enterprise value as described above.  

• When looking to carbon footprint major indices under the SFDR, we noticed that Enterprise Value Including Cash (EVIC) is expected as the denominator. Typically, Enterprise Value's main components are debt and cash which are not used by financial undertakings (e.g. banks) in the same way they are for non-financial undertakings. Banks are normally evaluated from loans and deposits. The ESAs recognise that the Enterprise Value definition in point 4 of Annex I of the Delegated Regulation was not specifically designed for credit institutions, but that definition is still meaningful and should be used as it provides an appropriate allocation mechanism to allow calculations to be made. Financial market participants should not develop their own definitions for the terms used in that definition.

>> cleversoft uses the standard definitions by the respective providers MSCI, Sustainalytics, S&P etc.

• If a financial market participant makes no investment decisions resulting in investments in sovereigns or real estate, then the rows in the template in Table 1 of Annex I corresponding to indicators for sovereigns and real estate should be left empty or with zero values. All the other indicators and fields should be completed by such a financial market participant

>> cleversoft will include this approach in the PAI Table as described above.

• PASI statement: should those disclosures relate only to financial products in scope of SFDR, or should those disclosures also relate to other types of instruments invested in by the financial market participant (e.g. structured bonds)? Should those disclosures also deal with own investments made on financial market participant’s own account? The scope of the PASI Statement is limited by the definitions of “financial market participant” in Article 2(1) SFDR, (i.e. credit institutions and investment firms should only cover their portfolio management activities and e.g. not their own account). Within this scope, FMPs have to consider all investment decisions for the disclosures under Article 4(1)(a), 4(3) or 4(4) SFDR.>> cleversoft is already considering all positions where the clients of an FMP are invested, as long as the client sends these positions to cleversoft.

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Product Disclosures

Main points relevant for the Product Disclosures

1. Which sections can be removed from the Pre-Contractual and Periodic disclosures

FMPs can remove the sections that are deemed not relevant for their financial product in the disclosure templates only if those sections are accompanied by a red text instruction that explicitly limits the scope of application of the section.

>> cleversoft is already taking these comments into consideration.  

2. Can a single financial market participant apply different interpretations of “sustainable investments” to different financial products that it offers?

FMPs can create their own framework for their financial products as long as they adhere to the letter of Article 2(17) SFDR. FMPs can create their own framework for their financial products if they adhere to the letter of Article 2(17) SFDR. Financial market participant should not, however, interpret Article 2(17) SFDR differently for different financial products that it makes available.

>> cleversoft is planning that all clients deliver a flag for “sustainable” investments for all instrument types, e.g. bonds, stocks, funds, etc.  

3. Can the objective-aligned index designated as a reference benchmark under Article 9(1) SFDR, i.e. the “designated index” referred to in 9(1)(a) or 9(1)(b), be a broad market index?

No, the requirement to explain “how” the designated index differs from a broad market index suggests that the designated index cannot itself be a broad market index, notwithstanding the accompanying “why” question.

>> cleversoft has already foreseen the differentiation between ESG Designated index and broad market index in the data model

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Taxonomy-aligned investment disclosures

1. Can taxonomy-aligned activities or PAI impacts from green bonds (or other specific project financing instruments like social bonds) be calculated for the projects they finance rather than taxonomy-aligned activities of or impacts arising from the issuer as a whole?

• Taxonomy Alignment

When calculating the proportion of taxonomy-aligned assets contributing to taxonomy-aligned economic activities, only the projects financed by green bonds under the future EU Green Bond Standard and other green bonds (the proportion of their value that corresponds to the share of the proceeds of those bonds used for environmentally sustainable economic activities) should be considered. As stated in Article 17(1)(b) of the Delegated Regulation, for its taxonomy-alignment KPI, a financial market participant can count an investment in a green bond up to the level of taxonomy-aligned activities the use of proceeds goes towards. The financial market participant should not take into account the issuer of such instruments for the purpose of the taxonomy-alignment KPI of the financial product

>> cleversoft considers green bonds as separate projects as long as this information is delivered by the data provider or client.  

• PAI disclosure

… financial market participants could adjust the metrics to reflect the fact that project financing bonds finance only specific activities and not the entire undertaking.  

Some PAI indicators in Table 1 of Annex I of the Delegated Regulation could be applied at “project” level and not company level where the investment is in a security that finances a specific project rather than the issuer issuing the security, for instance GHG emissions (Table 1, Indicator 1), land artificialisation (Table 2, Indicator 18) or rate of accidents (Table 3, Indicator 2), while some other PAI indicators could still be applied at company level such as the unadjusted gender pay gap (table 1, indicator 12).

>> cleversoft considers green bonds as separate projects as long as this information is delivered by the data provider or the client.  

2. An Article 9 SFDR product with 100% non-Taxonomy compliant climate objectives, would still fill the Taxonomy sections with 0% and the social sustainable investment section with 0%?

Such a financial product should indicate 0% in the graphical representation in the section “To what minimum extent are sustainable investments with an environmental objective aligned with the EU Taxonomy?”. In addition, it should disclose a 100% share under the heading “What is the minimum share of sustainable investments with an environmental objective that are not aligned with the EU Taxonomy”.

>> cleversoft will include a “taxonomyZero”-Flag, so that every client can decide on whether to include or exclude all the taxonomy questions and charts when taxonomy is equal zero.  

3. Lack of data is a major challenge for FMPs. Although this hurdle seems less pressing when it comes to investments in undertakings that fall under the scope of the future CSRD, how could FMPs overcome this lack of data

The ESG information chain is developing and both financial market participants and regulators may have to rely on the available data during the period before the application of the CSRD.

>> cleversoft will include a foot note with % ESG data available. All KPIs which cannot be calculated because of missing ESG Data will show n/a.  

4. The full reporting requirement under CSRD will not be applicable for non-financial companies until 1 January 2023. This means that before 2023, there will be no reliable data or calculation model available. Initial evidence shows that estimated data from data suppliers on Taxonomy-alignment of investment portfolios differ greatly between different suppliers, making it inappropriate/dubious to present such data to consumers. How are FMP supposed to fulfil the Taxonomy-alignment reporting requirements under the SFDR and the Delegated Regulation, respectively, given the lack of data? From a consumer’s perspective, the least misleading alternative would be to report ‘data not available’ coupled with a brief explanatory text.

As stated in Article 17(2)(b) and Recital (35) of the Delegated Regulation, when Taxonomy-alignment of investments is not available from the public disclosures of investee companies, then the use of ‘equivalent information’ from investee companies or third-party providers is permitted.

Once the reporting prescribed by Regulation (EU) 2021/2178 on the Taxonomy-aligned activities of non-financial undertakings (from January 2023) and financial undertakings (from January 2024) starts, the disclosure of Taxonomy-aligned investments is expected to become more straightforward.

>> cleversoft will include an option for the clients to add an alternative ISIN per security to be delivered as custom data mapping.  

5. How is it possible to practically apply the requirement to use “equivalent information” as referred to in Article 17(2)(b)?

The starting point for the evaluation of equivalent information, as referred to in Article 17(2)(b) of the Delegated Regulation, should be considered information that provides the same content and level of granularity as that provided by the reporting of undertakings of their Taxonomy-aligned activities in Regulation (EU) 2021/2178. In this respect, equivalent information should meet these following basic principles:

• Equivalent information should only apply to economic activities listed in the Delegated Acts of Regulation (EC) 2020/852;
• The assessment of the substantial contribution of an economic activity should rely on actual information, subject to the limited circumstances described by the European Commission in its May 2022 Union Law interpretation Q&A on pages 10-11; and
• While it should be possible to use estimates to assess the DNSH based on equivalent information, controversy-based approaches should be discouraged and considered insufficient (as outlined in Q&A 32 below).

6. What is to be reviewed by the third party: the internal process used to assess the Taxonomy-alignment or the data as such?

Article 15(1)(b) of the Delegated Regulation requires inclusion of a description of the investments underlying the financial product that are in Taxonomy-aligned economic activities, including whether the compliance of those investments with the requirements laid down in Article 3 of TR will be subject to an assurance provided by one or more auditors or a review by one or more third parties, and if so the names of the auditor or third party.

The review – which is an optional choice – does not necessarily have to include the internal process of the financial market participant as it should primarily address the investments made by the financial product in Taxonomy-aligned economic activities, specifically the compliance of those investments with the criteria for environmentally sustainable economic activities laid down in Article 3 TR. This review could focus on investments whose Taxonomy-alignment is not proven by disclosures made by undertakings under Article 8 TR. Where the Taxonomy-alignment of an investment is demonstrated by disclosures required by Article 8 TR, the review could choose not to carry out further verification with regard to the compliance of this investment with the criteria laid down in Article 3 TR, however the review could check that the financial product adequately reflects the Taxonomy-alignment in accordance with Articles 3, 5 and 6 TR, consistently with Article 8 TR disclosures.

>> cleversoft has already a narratives place holder, wo that every FMP can edit the explanation on their own.  

7. Once you have reported on your Article 5-6 TR financial product, should your precontractual information still be a minimum ambition or the actual achieved level of taxonomy aligned investments?

The pre-contractual disclosure should not include “targets” for Taxonomy-alignment, nor the actual achieved level of Taxonomy-aligned investments, but only the minimum proportion which the financial product commits to meet. The periodic disclosures are intended to appropriately reflect the Taxonomy-aligned investments achieved by the product, including where the actual Taxonomy-alignment is higher than the minimum proportion.

>> cleversofts' service gives already now every FMPs the possibility to provide the minimum proportion for Pre-Contractual Disclosures.  

8. Does the disclosure of the “minimum extent sustainable investments with an environmental objective aligned with the EU Taxonomy” have to be based on actual data or can it consist of a forecast calculation of the product’s ambition for taxonomy alignment? How should a new financial product comply with the requirement to publish the minimum proportion of investments when it has not made any investments?

Subject to sectoral rules governing pre-contractual disclosures in Article 6(3) SFDR and any relevant contractual commitments, the pre-contractual disclosure on the minimum share of sustainable investments, including the extent to which the investments are in environmentally sustainable economic activities, is a commitment that should be met at all times. The information about the degree to which investments are in environmentally sustainable environmental activities, as referred to in Article 15(1)(a) and 19(1)(a) of the Delegated Regulation, should be based on the actual investments the financial product makes in order to satisfy the requirement to disclose “how and to what extent” the investments are in environmentally sustainable economic activities. For new financial products (or financial products that want to change their investment strategy) those references for the calculation of the Taxonomy-alignment of the aggregated investments should be understood as “expected investments”. “Expected investments” can be considered the investable universe, which is analysed, and on the basis of this analysis, a decision about Taxonomy-alignment commitment is made.

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Overview of Art 8 Products incl. requirements on Taxonomy-alignment disclosure

Click here to see the overview.

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>> cleversoft will make sure that the template logic is adjusted accordingly for PreContractual and Web Disclosures.  

Further topics on MOPs and taxonomy alignment will be added in due course.

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cleversoft Services

Our Regulatory Watch team is closely monitoring any further developments on the SFDR and Taxonomy regulations. We offer standardised services on the full range of all 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.