Sustainable Finance update (asset management): Final Report on SFDR RTS regarding taxonomy-related disclosures

On 22 October 2021, the European Supervisory Authorities or ESAs (EBA, EIOPA and ESMA)  presented the European Commission with their Final Report on the draft Regulatory Technical Standards (RTS) regarding taxonomy-related pre-contractual and periodic disclosures under SFDR, as amended by the Taxonomy Regulation (Taxonomy RTS). 

The additional disclosure requirements in the Taxonomy RTS only concern those article 8 and 9 SFDR funds that make sustainable investments contributing to environmental objectives. It is interesting to note that the ESAs propose to treat these funds as a “subset” of a larger article 8 or 9 SFDR category, referring to them in the Final Report as “Article 5 and 6 products”.

As announced in its letter to the European Council and European Parliament dated 8 July 2021, the European Commission’s intention is to bundle all 13 RTS into one single delegated act with an expected application date of 1 July 2022. The ESAs approach in the draft Taxonomy RTS is therefore to amend the SFDR RTS, which were published on 4 February 2021 and which concern certain other disclosure requirements under SFDR, thereby creating a single rulebook.

Given that the ESAs lack the necessary powers to do so, the Final Report provides no guidance on how financial market participants should comply in the meantime with the taxonomy-related disclosure requirements in the primary legislation (i.e. articles 5 and 6 of the Taxonomy Regulation) which will start applying from 1 January 2022. 

According to the ESAs, the Taxonomy RTS reflect the responses received to the ESAs’ consultation paper which was published on 17 March 2021. In comparison to the initial draft RTS published as part of that consultation, the following new aspects can be highlighted:

1. The pre-contractual and periodic disclosure templates have been amended in order to change the order of certain sections and to reflect the ESAs’ proposed changes.
2. There is no longer a derogation for taxonomy-aligned sustainable investments to apply the Do No Significant Harm (DNSH) principle and as result the DNSH related-rules will apply to all sustainable investments.
3. From 30 December 2022, the disclosure whether Principal Adverse Impacts on sustainability factors are considered will also require information on how they are considered and a statement that information in this regard is available in the annual report (in line with the deadline for pre-contractual disclosure requirements of article 7(1) SFDR).
4. The biggest changes have been made to the asset allocation section regarding the requirement to show “how and to what extent” the underlying investments qualify as environmentally sustainable under the Taxonomy Regulation:

• To address the issue of potentially low KPIs where financial products have high exposures to sovereigns due to the lack of a reliable methodology to determine taxonomy-aligned activities funded by sovereign issuers, the ESAs propose a dual approach consisting of the calculation of two KPIs. The first KPI would be calculated including all investments in the denominator (including sovereigns) while the second KPI would be calculated in the same way but excluding all sovereign exposures. It will therefore be necessary to disclose two pie charts in the pre-contractual disclosure template (one including sovereigns and the other not).
• Clarification of the KPIs to be used for financial and non-financial undertakings.
• Regarding the question “how” underlying investments are taxonomy-aligned, while no mandatory audit is required, it needs to be disclosed whether compliance will be subject to an assurance provided by an auditor / third party.
• Following criticism during the consultation that sustainable investments with a social objective were not included in the initial draft of the Taxonomy RTS, these have now been expressly included, with a requirement to disclose the minimum share of social investments. 
• Infrastructure assets, securitisation positions and other article 5 and 6 Taxonomy Regulation products (e.g. funds) are now part of the list of investments that can be included in the numerator for the purpose of calculating the taxonomy-alignment of investments.
• Confirmation that due to a lack of reliable methodologies, derivatives should not be included in the numerator of the KPI to calculate taxonomy-alignment of investments (but to be included in the denominator).
• There is a requirement to apply netting when calculating taxonomy-alignment.

Next steps

The European Commission now has three months to decide whether to endorse the Taxonomy RTS.