Sustainable Finance update (asset management) – ESMA updates consolidated Q&A on SFDR with new ESA FAQs

On 25 July 2024, ESMA published a new consolidated version of the Q&A on SFDR, which includes a number of new questions and answers. While most of the fifteen new FAQs are clarifications or provide illustrations, some of the below mentioned ones could have a significant impact on the fund industry.

• The ESAs make it clear that registered AIFMs are required to comply with the website disclosures of Article 10 SFDR for Article 8 and 9 funds that they manage (either using their own website, that of the fund or a group website). If there is no website, one has to be established. (Question I. 4.)
• The ESAs clarify that financial market participants (FMPs) which deem sustainability risks not to be relevant for a financial product are not able to disapply any other obligations in relation to sustainability risks, such as the obligation of AIFMs to assess the exposure to sustainability risks set out in Article 18 (5) of Commission Delegated Regulation (EU) No 231/2013. (Question I. 5.)
• Further guidance is provided by the ESAs on how to take into account a number of Principal Adverse Impact indicators. The ESA notably explain that where an FMP (such as an AIFM or UCITS management company) aggregates the adverse impacts of its funds or if its funds are fund of funds, then there should be a look-through approach to the investee companies causing GHG emissions (for PAI indicator 1 GHG emissions). Financed emissions belonging to each scope from investee companies (i.e. 1, 2 or 3) should be allocated to the same scope at FMP level. (Question IV. 29.)
• In respect of sustainable investments (Article 2 (17) SFDR), the ESAs state that following the same logic as for PAIs, a look-through approach has to be followed when it comes to sustainable investments, meaning that the underlying investments will need to be assessed to ensure they qualify as a sustainable investment. Importantly, this means that for funds investing through underlying funds, FMPs cannot only rely on the disclosures in the underlying fund’s documentation but will need to ensure (through due diligence) that the underlying investments comply with their own sustainable investment test. (Question V. 22.)
• The ESAs state further that where an FMP delegates the portfolio management to an investment manager, it must ensure that any investments considered “sustainable investments” conform to its own application of Article 2 (17) SFDR. If the relevant investment does not meet the FMP’s own definition of a sustainable investment then the investment cannot be considered a sustainable investment for the delegating FMP’s financial product. The requirement for an FMP to impose its own sustainable investment test on delegates and to monitor compliance is not current market practice and is likely to create significant problems for AIFMs and UCITS management companies (such as third-party management companies), which have delegated the portfolio management to third-party investment managers. (Question V. 23.)
• The ESAs further clarify (in line with CSSF guidance) that efficient portfolio management techniques (EPM) can only fall into the non-sustainable bucket of Article 9 funds if they are used for hedging or liquidity purposes. According to the ESAs, money market funds (MMF) are not automatically considered as liquidity and their classification depends on the type of MMF, e.g. on whether the MMF qualifies as cash equivalent under the IFRS accounting rules (i.e. if it is readily convertible to known amounts of cash subject to an insignificant risk of changes in value). (Question V. 24.)
• Regarding the good governance test of Article 8 SFDR, the ESAs confirm that real assets like cars or real estate held in SPVs or holding companies do not require a good governance check. (Question V. 27.)

While the ESAs’ additional guidance is generally welcome, it would have been preferable at this stage to await the outcome of the EU Commission’s review of SFDR instead of providing potentially far reaching interpretative guidance on sustainable investments, which is likely to lead to further compliance burdens for the fund industry.