European Commission’s response to questions on the interpretation of SFDR

On 14 July 2021, the European Commission (EC) responded to the letter of 7 January 2021 addressed to it by the European Supervisory Authorities (ESAs) in relation to the application of  Regulation (EU) 2019/2088 on sustainability - related disclosures in the financial services sector ( “SFDR”). The response took the form of a question and answer document (Q&A). The key points of this Q&A can be summarised as follows.

On the questions of applicability:

1. To the question whether the SFDR applies to registered AIFM as referred to in Article 3(2) of the alternative investment fund managers’ directive (“AIFMD”), the EC has responded affirmatively. AIFMs as defined in article 2(1) of the SFDR includes registered AIFM. In this respect, entity and financial product related requirements of the SFDR would also apply to them. Given the fact that disclosures to investors referred to under Article 23 (1) of the AIFMD as well as the requirement for annual reports pursuant to Article 22 of AIFMD registered AIFMs should apply those provisions by analogy (such information is to be included in pre-contractual and periodic documentation made available to the end investors under national law).
2. To the question whether the SFDR applies to non-EU AIFMs when they market EU alternative investment funds on the basis of the national private placement regime, the answer is yes. Non-EU AIFMs must ensure compliance with SFDR, including the financial product related provisions (i.e. at product level).
3. To the question whether website disclosure as foreseen in Article 10 of the SFDR applies to tailored financial products given by clients of an investment firm providing investment advice on a discretionary client-by-client basis, the EC responds that the definition of financial products in Article 2(12) SFDR does not distinguish between tailored and standardised products. Therefore the disclosure obligations apply to both of these categories without distinction. 

Questions on Principal Adverse Impacts

1. Pursuant to Article 4(1) and (2) of the SFDR financial market participants can decide whether to consider principal adverse impacts (“PAI”) or not. However, by way of derogation and pursuant to Article 4(4), financial market participants which are parent undertakings of large groups exceeding, on a consolidated basis, an average number of 500 employees, have to take PAI into consideration.
2. The question asked is whether the calculation of the 500-employees threshold is to be applied to both EU and non-EU entities of the group without distinction as to the place of establishment of the group and/or subsidiary, and should the due diligence statement include impacts of the parent undertaking only or must it include the impacts of the group at a consolidated level. The EC clarifies that the calculation of the headcount takes into account the number of employees of a parent undertaking and of subsidiary undertakings regardless of whether they are established inside or outside the Union.
3. As regards the due diligence policies with respect to PAI these obligations are imposed on the parent undertakings which in this capacity set the group wide policies. Therefore the parent undertaking must publish and maintain the requested information (set out under Article 4(4) of the SFDR) adapted to the specific situation of the parent undertakings and not the group as a whole. 

Questions on Article 8 or Article 9 of the SFDR

1. The question raised was whether the product falling under Article 9 (1), (2) or (3) of SFDR can only invest in sustainable investments as defined in Article 2(17) of the SFDR and if not, is there a minimum share of sustainable investments required. 
   The EC responds that such products may in addition to “sustainable investments” include investments for certain specific purposes such as hedging or liquidity which, in order to fit the overall sustainable investments objective have to meet minimum environment or social safeguards. 
2. The second question was whether when an EU Climate Transition Benchmark (EU CTB) or EU Paris-aligned Benchmark (EU PAB) exists, does the product have to track an EU PAB or an EU CTB on a passive basis to fall within the scope of 9(3) (financial product having reduction of carbon emissions as their objective)?  The EC clarifies that where an EU CTB or EU PAB exists, a financial product must be tracking these. 
   Where such a benchmark does not exist, the pre-contractual information must include a detailed explanation of how the continued effort of attaining the objective of reducing carbon emissions is ensured in view of achieving the long-term global warming objectives of the Paris Agreement. 
3. Pursuant to Article 8 of the SFDR financial products have to promote environmental and social characteristics. The question asked is whether the inclusion of the word “sustainability” or “sustainable” or “ESG” would be sufficient to qualify a product to be promoting environmental or social characteristics and whether the financial product has to invest a minimum share of its investments to attain its designated environmental or social characteristic in order to be considered to be “promoting environmental or social characteristics”. Is sectoral exclusion sufficient to qualify as promotion?

The EC responds that Article 8 of the SFDR remains neutral in terms of design of financial products and does not prescribe composition of investments or minimum investment threshold or eligible investment targets. These financial products, may continue to apply various market practices and tools (or a combination thereof) such as screening, exclusion strategies or best-in-class. Article 8 means that where a financial product complies with certain environmental, social or sustainability requirements, including international conventions or voluntary codes, and these characteristics are “promoted” in the investment policy of the financial product then the financial product is subject to Article 8 of the SFDR. The term “promotion” is very largely defined. The financial product must refer in the pre-contractual disclosures to those elements which relates to their environmental and/or social characteristics which are binding during the whole holding period.