The EU Q&A on sustainability-related disclosures in the financial services sector (SFDR)

• Europe

• ESG
• Financial services and markets regulation - ESG
• Financial services disputes and investigations
• Investment funds and asset management
• The future of funds - ESG

04-10-2021

The European Commission published its questions and answers (the “Q&As”) on application of Regulation EU 2019/2088 on sustainability-related disclosures in the financial services sector (“SFDR”) at the end of July.  The Q&As address issues relating to the application of SFDR which the European Supervisory Authorities (“ESAs”) identified as priorities in their letter to the European Commission dated 7 January 2021.  This briefing explores the implications for asset managers.

1. Application of SFDR to registered AIFMs referred to in article 3(3) AIFMD

In recent years, fund promoters in certain EU jurisdictions have increasingly opted to set up funds managed by registered AIFMs (contrasting with EU authorised AIFMs).  Given the size of such entities and their exemption from AIFMD, it was not clear whether they were expected to comply with SFDR to the same extent as authorised AIFMs fully within the scope of AIFMD.  The Q&As state that registered AIFMs must comply with SFDR provisions including the entity and financial product-related requirements, as registered AFMs are not covered by the list of exceptions provided in article 17 SFDR. 

Under article 23(1) AIFMD registered AIFMs are not obliged to provide disclosures to investors.  Under article 22 AIFMD registered AIFMs are not obliged to provide annual reports to investors.  Accordingly, registered AIFMs should make pre-contractual disclosures to investors under article 6(3)(a) SFDR and annual report disclosures related to article 8 or 9 SFDR products under article 11(2)(1) SFDR by means of pre-contractual and periodic documentation made available to investors under national law.   

2. Application of SFDR to non-EU AIFMs marketing AIFs domiciled in EU

The Q&As state SFDR applies to AIFMs as defined in article 4(1)(b) AIFMD.  This includes both European Union and third country AIFMs.  The only basis on which third country AIFMs can access EU markets is through Member State national private placement regimes (“NPPR”).  When seeking access under NPPR third country AIFMs must comply with SFDR. 

3. Application of Article 4(4) SFDR

Article 4(4) SFDR provides that large financial market participants, including parent company and subsidiary groups which taken together are large financial market participants, must publish a statement summarising their due diligence policies for principal adverse impacts of investment decisions on sustainability factors on their websites.  Article 3(7) of the Accounting Directive (2013/34/EU) defines a large financial market participant as one with an average of more than 500 employees.

(i) Mechanism under article 4(3) and 4(4) SFDR

The Q&As note that the aim of article 4(3) and (4) SFDR is to introduce a stringent disclosure mechanism.  Large financial market participants must, on an individual or group basis, publish a statement summarising their due diligence policies for principal adverse impacts (as opposed to adverse  impacts) of investment decisions on sustainability factors on their websites.

Note that a group will not be considered to be a large financial market participant unless the parent entity of the group is a financial market participant.

(ii) 500 employees threshold  

The Q&As provide that when calculating the number of employees for the purposes of the 500 employee threshold under article 4(4) SFDR, all employees should be counted regardless of where the parent company and subsidiaries are incorporated, including outside the EU.

(iii) Publication of due diligence policies

The Q&As clarify that under article 4(4) SFDR, a parent company acting in its own right as a financial market participant should publish its own statement of due diligence policies rather than one for the group of which it is a part.

4. Application of article 9 SFDR

Article 9 SFDR applies to financial products with a sustainable investment objective.  The Q&As focus on the threshold sustainable investment financial products must meet in order to fall into article 9.

(i) The minimum threshold of sustainable investments for financial products to comply with article 9 and the concept of “sustainable investment”

The Q&As point out that sustainable financial products which do not have sustainable investment as their objective are considered article 8 products. 

Article 9 products must only invest in sustainable investments as defined under article 2(17) SFDR.  Article 9 financial products may include investments for specific purposes such as hedging or liquidity in order to meet requirements of prudential or sector-specific rules, provided those investments meet the sustainable investment objective.

As article 9 SFDR is neutral as to product design and investing styles, product documentation must explain how such features fulfil the sustainable investment objective in order to comply with the “do no significant harm” principle.

This answer confirms the approach the market has started to take in relation to Article 9.  In particular we note that firms should read the phrase ‘have as their objective sustainable investment’ as ‘plan to invest in sustainable investments’ rather than ‘whose investment objective is sustainable investment’ since it appears that an Article 9 product  requires an intention to invest sustainably instead of an explicit non-financial investment objective.

(ii) Application of article 9(3) SFDR, EU Climate Transition and EU Paris-aligned Benchmarks

The Q&As note that the objective under article 9(3) SFDR of a reduction in carbon emissions complies with the definition of sustainable investments in article 2(17) SFDR.  

Until the EU Paris-aligned Benchmark (“PAB”) and EU Climate Transition Benchmark (“CTB”) are finalised and commence publication, an article 9 financial product’s pre-contractual information must include a detailed explanation of how it will help achieve the objectives of the Paris Agreement or how it will help reduce carbon emissions to support climate transmission.  Once the PAB and CTB are published, an article 9 financial product must track them, however the Q&A do not specify whether passive or active benchmark tracking is required.

5. Application of article 8 SFDR

Article 8 SFDR applies to financial products with environmental and social objectives which take into account more than just the sustainability risks required by article 6 SFDR but do not have sustainable investments as their sole objective as is required by article 9 SFDR.    

The Q&As attempt to distinguish between the three types of product.

(i) Differences between article 8 and 9 SFDR products and between article 6 and 8 SFDR products.

The Q&As note article 8 SFDR is neutral as to the design and features of financial products and different article 8 products may use a variety of market practises, tools and strategies (including screenings and exclusion strategies) or redistribution of profits or fees.

Article 8 products may pursue the objective of reduction of negative externalities caused by the underlying investments, such as principal adverse impacts on sustainability factors or even to invest, in part, in sustainable investments defined in article 2(17) SFDR.  On the other hand, mere integration of sustainability risk as defined in article 2(22) SFDR is not sufficient to place financial products within the scope of article 8 SFDR.

(ii) Minimum share of investments which must have environmental or social characteristics in order for a  financial product to comply with article 8 SFDR

The Q&As note that article 8 SFDR is neutral as to investment strategy and sets no composition, minimum thresholds, or eligible assets in which financial products must invest.

(iii) Concept of “promotion” of social and environmental characteristics

The Q&As note that under article 8 the concept of “promotion” is broadly drawn and a financial product can be considered to promote a social or environmental characteristic by direct claims, indirect claims and even the mere implication that the financial product considers environmental or social characteristics when determining its investment policies, targets or a general investment objectives.  

An article 8 promotion can arise from the wording of issuing documents, fund memoranda, term sheets, pre-contractual and periodic documents, marketing communications, advertisements, provision of information on the adherence to sustainability-related financial product standards and product labels.   

(iv) Use of specific product names, compliance with national law requirements and application of article 8 SFDR

The Q&As note that the use of specific product names or designations can constitute promotion for article 8 SFDR. Action taken to comply with specific statutory requirements under national law may also constitute “promotion” and bring financial products within the scope of article 8 SFDR.

6. Application of SFDR to portfolios and other types of financial products managed on a discretionary basis

The Q&As note that the definition of a financial product in article 2(12) SFDR includes portfolios and other financial products managed on a discretionary basis.  All financial products, including those managed on discretionary basis which promote environmental or social characteristics or have sustainable investments as their objective, must ensure compliance with the EU and national data protection laws as well as confidentiality duties owed to clients when making website disclosures in accordance with article 10 SFDR.  

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