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The European Securities and Markets Authority (ESMA) published Questions and Answers (Q&A) on the interpretation of Regulation (EU) 2019/2088.
The Q&A clarifies a number of points including those relating to definition of sustainable investments, periodicity of generation for periodic disclosure, clarifications on products that promote ot habe as an objective the reduction in carbon emissions, and others.
In this article you will find a summary of the points affecting the SFDR Disclosures and how cleversoft will handle these.
Q1. How does the definition of “sustainable investment” in Article 2, point (17) SFDR apply to investments in funding instruments that do not specify the use of proceeds, such as the general equity or debt of an investee company? For example, would an investment in an investee company which has one economic activity, among several other economic activities, that contributes to an environmental or social objective (and none of the economic activities significantly harm any environmental or social objective and the company follows good governance practices) be considered to be a “sustainable investment” as a whole or in part?
A1. The definition of sustainable investment, as outlined in Article 2, point (17) of the SFDR, does not specify a particular method for evaluating how an investment contributes to environmental or social objectives. Financial market participants (FMPs) are required to disclose the methodology they have applied in conducting their assessment of sustainable investments. This includes how they have determined:
The reference to ‘economic activities’ in the definition of sustainable investment outlined in Article 2, point (17), SFDR appears to be aimed at scenarios where funds are directed towards a particular project or activity, or towards a company involved in a single type of activity.
The Q&A Paper outlines that It is possible to evaluate the sustainability of an investment not only based on a particular activity but also at the company level. As an example, products like UCITS and AIFs, defined in Article 2, point (12) of SFDR, can invest in the overall equity or debt of a company. Additionally, investments in portfolios of shares or bonds of companies based on Paris-aligned or Climate Transition Benchmarks (PAB or CTB) are considered sustainable under Article 9(3) SFDR. (Refer to answer 5 for further details.)
Cleversoft: cleversoft understands the current market situation that every FMP is defining whether a position is sustainable or not on their own. For this reason, we offer the possibility to import custom data for 1) investments with E/S Characteristics and 2) Sustainable investments.
Q2. How should “investment in an economic activity that contributes to an environmental objective” or “investment in an economic activity that contributes to a social objective” in Article 2, point (17), SFDR be interpreted? Are any (or all) of the following features sufficient for an economic activity to meet the definition of Article 2, point (17) SFDR, i.e. to contribute to an environmental (or a social) objective?
a) should the economic activity being carried out by the investee company in itself contribute to an environmental or social objective (for example, an issuer investing in micro-finance activities in the developing world to assist in the development of socially disadvantaged communities)?; and/or
b) can any economic activity potentially contribute to an environmental or social objective simply because it is carried on in a sustainable manner by the investee company (examples: (1) an investee company manufacturing a product in a more environmentally sustainable way than its peers/the sector, or (2) an undertaking that stands out for its social impact, for instance through its HR management or the representation of women); and/or Can any economic activity contribute to the general environmental objective of climate change mitigation if it is only covered by a transition plan (for instance a plan aiming to reach climate neutrality based on the ACT methodology)?
A2. To meet the criteria of being a ‘sustainable investment’ as outlined in Article 2, point (17) of the SFDR, a financial product must satisfy the following conditions:
The SFDR does not specify any minimum criteria for concepts like “contribution,” “do no significant harm,” or “good governance,” which are the essential factors of a ‘sustainable investment.’ As a result, financial market participants need to evaluate each investment individually and disclose the assumptions they have used. This policy decision places greater responsibility on financial market participants, and they must be careful while evaluating the key factors of a ‘sustainable investment.’
Cleversoft: cleversoft understands the current market situation that every FMP is defining whether a position is sustainable or not on their own. For this reason, cleversoft offers the possibility to import custom data for 1) investments with E/S Characteristics and 2) Sustainable investments.
Q3. Article 9(3) SFDR, carbon emissions reductions and other benchmark questions: From Article 9(3) SFDR and the Commissions Q&A answer regarding that Article in July 2021 (which outlined the principle that SFDR is neutral in terms of product design), is it correct to consider that financial products that have an Article 9(3) objective of reduction in carbon emissions can be either products with a passive or active investment strategy? If financial products with an active investment strategy can be financial products that have reduction in carbon emissions as their objective under Article 9(3) SFDR, are there any specific requirements they should meet when they have designated an index as a reference benchmark?
A3. Financial products that have as objective the reduction in carbon emissions can be set as Art 9 products under Article 9(3) regardless of whether they use a passive or active investment strategy.
SFDR does not require the use of Paris-Aligned Benchmarks (‘PAB’) or Climate Transition Benchmarks (‘CTB’) nor the use of any other specific type of index.
Where no PAB/CTB is passively tracked, the SFDR requires a detailed explanation of how the continued effort of attaining the objective of reducing carbon emissions is ensured in view of achieving the long-term global warming objectives of the Paris Agreement.
This is also reflected in the Delegated Regulation (EU) 2022/1288 – Art 49 (3), which requires financial market participants to provide clear information on how a financial product adheres to the methodological guidelines established in Commission Delegated Regulation (EU) 2020/1818.
Cleversoft: Cleversoft’s service offers the flexibility to display or hide relevant questions on benchmarks and provide narrative descriptions as required on the SFDR document, depending on the different product types. The necessary logic is built into the templates.
Q4. Can a financial product “promote” carbon emissions reduction as an “environmental characteristic”, as opposed to having it as an “objective”? In other words, can a financial product disclose carbon emissions reduction as an environmental characteristic under Article 8 SFDR, or should any financial product which targets carbon emissions reduction as a feature always be considered to be having “carbon emissions reduction” as an “objective” and therefore be required to disclose the information required by Article 9(3) SFDR? In this example, if the financial product is considered an Article 8 SFDR product, what would be the criteria to differentiate it from an Article 9 SFDR product?
A4. Article 8 of the SFDR does not limit the types of characteristics that can be promoted by financial products. The regulation does not prevent a product from promoting carbon emissions reductions as part of its investment strategy if the product does not have sustainable investment as its objective.
The information presented in pre-contractual, website, and periodic disclosures should not give investors the impression that a product’s objective is to promote sustainable investment under Article 9(3) merely by highlighting its carbon emissions reduction characteristics. As per Art 13, SFDR marketing materials should not create the impression that a product pursues sustainable investment, where the promotion of carbon emissions reductions is only a mere characteristic of the product’s investment strategy.
Q5. Can financial products with a passive investment strategy which designate as a reference benchmark either a Paris Aligned Benchmark or (from 1 January 2023) a Climate Transition Benchmark automatically be deemed to fulfil the conditions of Article 9(3) SFDR in conjunction with Article 2(17) SFDR? Likewise, can financial products with an active investment strategy focused on carbon emissions reduction be deemed to satisfy the conditions of Article 9(3) SFDR in conjunction with Article 2(17) SFDR where they apply the same requirements (regarding selection criteria, etc.) as those applied by PAB and CTB pursuant to the BMR framework and in particular Commission Delegated Regulation (EU) 2020/1818?
A5. Article 9(3) SFDR mandates that information regarding low carbon emission exposure and its alignment with the Paris Agreement’s long-term global warming objectives must be included in the disclosure requirements outlined in Article 6(1) and (3) SFDR.
Article 9(3) second subparagraph defines that in the case of no EU Climate Transition Benchmark or EU Paris‐aligned Benchmark, Article 6 requires that the information disclosed should provide a comprehensive explanation of the measures taken to achieve the goal of reducing carbon emissions and ensure that such efforts align with the Paris Agreement’s long-term global warming objectives.
Financial products which are passively tracking Paris Aligned Benchmarks (PABs) and Climate Transition Benchmarks (CTBs), are deemed to have sustainable investments as defined in Article 2, point (17) SFDR as their objective (not falling under Article 9(3) second subparagraph). Hence, FMPs do not have to provide a detailed explanation of how the continued effort of attaining the objective of reducing carbon emissions is ensured in view of achieving the long‐term global warming objectives of the Paris Agreement, as these products are deemed to have sustainable investments as defined in Article 2, point (17) SFDR as their objective.
Financial market participants must explain why they consider that products focused on carbon emissions reduction that are actively managed, i.e. that do not strictly track a PAB or CTB, have sustainable investment as their objective.
Cleversoft: Cleversoft’s service offers the flexibility to display or hide relevant question on benchmarks and provide narrative descriptions as required on the SFDR document, depending on the different product types. The necessary logic is built into the templates.
Q6. PAI consideration: What is the meaning of “consider” in Article 7(1), point (a), SFDR? Could “consideration” of principal adverse impacts by a financial product mean that a financial product only discloses the relevant principal adverse impacts of the investments, for example total greenhouse gas emissions, or does “consideration” require the disclosure of the action taken by the financial market participant to address the principal adverse impacts of the product’s investments, such as engagement with investee companies, and are there any minimum criteria for such actions?
A6. Article 7(1) defines the disclosure obligation on FMPs for financial products that fall under Art 4, SFDR and have to be reported in the PASI Statement.
The disclosure requirement pertains to the consideration of principal adverse impacts of sustainability factors in financial products. Recital 18 further elaborates that financial market participants must integrate procedures for evaluating such impacts, including in their due diligence processes, based on their activities, scale, and the types of financial products offered, if they deem such impacts to be material: ““where financial market participants, taking due account of their size, the nature and scale of their activities and the types of financial products they make available, consider principal adverse impacts, whether material or likely to be material, of investment decisions on sustainability factors, they should integrate in their processes, including in their due diligence processes, the procedures for considering the principal adverse impacts alongside the relevant financial risks and relevant sustainability risks. […] Financial market participants should include on their websites information on those procedures and descriptions of the principal adverse impacts.” As a result, the adverse impact description must encompass both the nature of the adverse impacts and the measures adopted to mitigate them.
Q7. 500 employee principal adverse impact (PAI) threshold: For the purposes of Articles 4(3)-4(4) SFDR, should “the average number of 500 employees” be understood to include workers who are assigned to the financial market participant even though they are employed by a third party that invoices their services back to the financial market participant, e.g. interim workers or workers that are employed by other organisations within a group for instance as part of shared-service centres? Furthermore, can the exemption in Article 23(5) of the Directive 2013/34/EU of the European Parliament and of the Council4 (‘Accounting Directive’), which grants Member States the right to exempt parent companies that are themselves the subsidiary of a larger group from drawing up consolidated financial statements and a consolidated management report under that Directive, apply to a “parent undertakings of a large group” as referred to in Article 4(4) SFDR?
A7. Unless otherwise defined by an applicable Union legal act, the determination of who qualifies as an employee is typically determined by national law.
As SFDR does not provide an employee definition, it should be determined by referring to the employee definition in the relevant national law.
Q8. Periodic disclosure frequency for portfolio management services: The frequency of periodic reports in case of portfolio management services is determined by Article 11(2), point (i) SFDR, which refers to Article 25(6) of Directive 2014/65/EU of the European Parliament and of the Council5 . Article 60 of Commission Delegated Regulation (EU) 2017/5656 provides the details of the periodic reporting requirements for portfolio management services, including their frequency. Based on that text, this reporting should be provided quarterly, with certain exceptions. However, recital 21 of SFDR states that “…Those disclosures by means of periodic reports should be carried out annually”. Considering all the above, should financial market participants in scope provide a quarterly (with exceptions according to Article 60 of Delegated Regulation (EU) 2017/565) periodic report based on the SFDR templates for portfolio management, or can the financial market participants use one of the quarterly reports to present a yearly report based on the SFDR templates for portfolio management?
A8. According to the Q&A Paper the legal drafting of Article 11(2), points (h) and (i), SFDR combined with recital 21 of the SFDR, clearly indicates the intention of the co-legislators that only one annual periodic report is required.
The periodic report to be added to the portfolio management services template for the fourth quarterly report, as per the directives of Article 25(6) of Directive 2014/65/EU and Article 60 of Delegated Regulation (EU) 2017/565, must follow the periodic report templates provided by the SFDR Commission Delegated Regulation (EU) 2022/1288.
Cleversoft: Cleversoft’s service supports already today the yearly generation of periodic disclosures, including average calculation over the four quarters for all relevant SFDR Indicators.
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