Insight

SFDR latest updates: How good is good enough?

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A little over a year into the EU’s Sustainable Finance Disclosure Regulation (SFDR) regime, firms are struggling to keep pace with regulatory change—specifically the April 2022 delegated regulation that laid out regulatory technical standards (RTS) under SFDR.

The RTS were released to clarify the content, methodologies and presentation of the key data that financial market participants and advisers are required to include in sustainability disclosures, including impact statements, pre-contractual disclosures and periodic disclosures.

The RTS are not expected to take effect until January 2023, but questions from fund management companies still abound on how they should implement the letter of the law.

Some reporting requires that underlying companies share a few key figures, but access to that data gets complicated where there is a lack of control and direct oversight, as in venture capital. In some cases, the investee company doesn’t even have the data required—but the onus is still on the reporting firm to share required information with regulators.

For now, regulators are tolerant of firms employing their best efforts—but it remains unclear what qualifies as a ‘best effort,’ and how good is good enough. I wrote recently about SFDR updates as of April 2022; in this post, I’ll outline additional clarifications and finish with recommended next steps.

May 2022 SFDR Q&A clarifications

On 25 May 2022, the European Securities and Markets Authority (ESMA) published responses to questions raised in the second SFDR Q&A issued by the European Commission. Responses from this most recent Q&A will likely impact fund managers’ compliance preparations ahead of the RTS as well as their approach to compliance with SFDR overall.

Key clarifications in this Q&A round for fund managers include:

  • Product-level consideration of principal adverse impacts (PAIs): Fund managers opting out of entity-level PAI consideration can still consider product-level PAIs as part of the investment strategy of an underlying fund
  • Disclosure of no Taxonomy-aligned investments: If a fund’s investments are not Taxonomy aligned, then ‘zero’ must be indicated in response to the Taxonomy alignment question in the fund’s offering document and periodic report
  • Limitations on narrative explanations of ‘zero’ Taxonomy-aligned investments: The Commission believes that narrative explanations may run counter to the purpose of Taxonomy disclosures. This issue is of particular concern to fund managers because of the widely acknowledged challenges with gathering the required disclosure data; to date, funds have often explained a lack of alignment by citing the lack of data
  • SFDR application to existing funds: Funds in existence on 10 March 2021 (the first effective date of SFDR) that continue to be available to investors after that date are in scope of SFDR disclosure rules. For funds that are not made available to investors after 10 March 2021, it is necessary to determine if they fall within Article 8 or 9 and then provide any relevant website and periodic disclosures

June 2022 ESA Joint Committee statement

Further, in June 2022, the Joint Committee of the European Supervisory Authorities (ESAs) published a statement further clarifying the draft RTS.

This statement covers:

  • Use of sustainability indicators
  • Principal adverse impact disclosures
  • Financial product disclosures
  • Direct and indirect investments
  • Taxonomy-related financial product disclosures
  • ‘Do not significantly harm’ disclosures
  • Disclosures for products with investment options

Next steps for fund managers

Fund management firms should familiarise themselves with the clarifications outlined in this most recent Q&A. They will likely need to adjust both their current approach to SFDR compliance and their plans for the upcoming SFDR Level 2 deadline of January 2023.

Funds that remain unclear on what applies to them (and when) should consult an expert sooner than later.

Experienced professionals can help collect and draft disclosure data, establish achievable ESG targets, amend management systems, and more. Contact IQ-EQ’s team of experts today.