As the financial industry continues to call for more clarity and guidance to handle what even supervisors see as the «astonishing» complexity of the emerging EU framework for sustainable finance, impact investments and ESG, European regulators have added a range of technical details to sustainability rules over recent weeks.
On May 26 the European Commission answered some of the questions from supervisory authorities on the Sustainable Finance Disclosure Regulation, known as SFDR, and the taxonomy. Five days later the European Securities and Markets Authority, Esma, issued a risks and disclosures briefing, and on 2 June the supervisors, the ESAs, added their own clarifications on the SFDR’s regulatory technical standards.
One Esma official, speaking at a conference in Luxembourg, recently flagged that EU authorities were preparing more detailed guidance and said the authorities believe that, while understanding that the rules are complex, often incomplete and that the deadlines are tight, this is ultimately worthwhile work.
The European Commission’s 11 pages of replies to ESA queries about the SFDR and taxonomy covered a range of technical sticking points. These included precisions around principal adverse impacts, disclosure requirements, grandfathering practices and the advisory process.
Minimum governance standards required
In a couple of questions, Esma asked whether Article 8 (‘ESG’) and Article 9 (‘impact’) funds could include investments in securities issued by companies or governments, even if there was no clear specification of good governance practices. The Commission said that minimum governance standards are required for investee companies but not for sovereign bonds.
Industry representatives have complained that these requirements for the financial sector are not yet aligned with the requirements for companies in which they can invest. While funds are expected to report back on the impact of their investments, companies in which they can invest are not yet required to report on their own as the particular requirement of the SFDR has yet to enter into force when it comes to corporate reporting.
Esma’s 16 page “Sustainability risks and disclosures in the area of investment management” supervisory briefing, also got into the weeds of ESG rules, offering non-binding advice to regulators. While not being rules in themselves, this briefing provides pointers to the future direction of travel for regulatory developments.
Advice on the desired content of fund documentation and marketing material was highlighted. In particular this included guidance on pre-contractual and periodic disclosures to the supervisory authorities, and the details such as how ESG topics are dealt with in fund documentation and marketing material.
Esma also suggested ensuring that depositaries should be supplied with sufficient data to monitor compliance with instructions from the management company or portfolio manager. How Ucits ManCos and AIFMs integrate sustainability risks also needs to be checked. The Paris-based super regulator also highlighted where supervisors should consider sanctioning market players regarding failures to meet SFDR disclosure rules.
Clarifications on SFDR
Most recently, the 12-page “Clarifications on the ESAs’ draft RTS under SFDR” was released. Key areas covered are clarifications around the use of principal adverse impact, or PAI, indicators, financial product disclosures and do-no-significant harm disclosures.
This includes a table listing three possible uses of the adverse impact indicators at financial product level, details on PAI calculation methodology, and to which investments in which types of assets these rules should apply. There is also guidance related to taxonomy-related financial product disclosures, and disclosures for financial products with investment options.
While these precisions will give some guidance to financial product providers as they grapple with the new, complex ESG rules, many more questions persist. It will come as some comfort that regulators understand the challenges being faced.
Incomplete and imperfect
“We acknowledge that the sustainability disclosure framework is incomplete and imperfect at this time,” Verena Ross, chair of Esma, told the Irish Funds Annual Global Funds Conference 2022 on 31 May.
“In an ideal world, the disclosures required for financial market participants and financial products would have followed a comprehensive corporate transparency regime…[but this]… is still work in progress though - through the CSRD, its accompanying reporting standards, and not forgetting the global standards being promulgated by the ISSB.”
Ross said she believes this work “will help to complete the picture and significantly improve the underlying sustainability information over time.”
Ross also accepts that substantial work is required to reduce the complexity of SFDR and make them easier for retail investors to understand. “This was consistent feedback we received…during consumer testing of the product templates,” she said, adding “but the underlying complexity of the information is, and will continue to be, a persisting challenge.”