Sustainable Finance Insight Series - 16 | ESAs’ Report on the extent of voluntary disclosure of principal adverse impact under article 4 (1) of the SFDR

On the 28 July 2022, the European Supervisory Authorities (“ESAs”) issued a joint report to the European Commission on disclosures of principal adverse impacts (“PAIs”) of investment decisions on sustainability factors, in accordance with article 18 of Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability-related disclosures in the financial services sector (“SFDR”) which provides that the ESAs shall take stock of the extent of voluntary disclosures in accordance with point (a) of article 4(1), and shall submit annually a report to the European Commission on best practices and make recommendations towards voluntary reporting standards (“Report”).

In order to draft the Report, the ESAs have conducted a survey of the national competent authorities (“NCAs”), with the purpose of gathering feedback on the current state of financial market participants[1] (“FMPs”) voluntary disclosures under article 4 (1) point (a) and (b) of the SFDR, although article 18 of the SFDR did not cover article 4 (1) point (b).

As a reminder, article 4 (1) point (a) of the SFDR provides that FMPs shall publish on their websites, where they consider PAIs of investment decisions on sustainability factors, a statement on due diligence policies with respect to those PAIs, whereas article 4 (1) point (b) of the SFDR provides that FMPs shall publish on their websites, where they do not consider PAIs of investment decisions on sustainability factors, clear reasons for why they do not do so, including, where relevant, information as to whether and when they intend to consider such PAIs. In short, article 4 (1) requires, on a comply or explain basis, FMPs to disclose on their website whether they consider PAIs in their investment decisions on sustainability factors. It should be noted, however, that the disclosure required by article 4 (1) (a) is mandatory for FMPs that have at least 500 employees by consolidating their subsidiaries.[2]

Key takeaways of the Report

Although there is no perceptible trend as disclosures varies significantly across jurisdictions and FMPs, the key takeaways are the following:

- Article 4 (1) (a)

• it is advisable to mention the methodology used for the assessment of PAIs;
• acknowledging the lack of data in certain fields as a caveat after describing the process regarding the consideration of PAIs is appropriate;
• PAIs should not be confused with sustainable risks;
• the statement to be aligned with the Paris Agreement on climate change should be accompanied with further details like the alignment scenario choice and alignment monitoring procedures.

- Article 4 (1) (b)

• disclosures of FMPs that do not take into account PAIs of investment decisions on sustainability factors frequently omit to provide (i) details, (ii) clear reasons for why the FMP do not do so, (iii) sufficient information as to whether and when the FMP intends to consider such PAIs;
• disclosures of non-consideration of PAIs should not be combined with:
  • disclosures of information under article 3 (1) which concerns policies on the integration of sustainability risks in FMPs decision-making process or any other ESG elements that could potentially be misleading; and
  • the claim that the FMP’s investment decisions have a positive impact on sustainability factors – the aim of the EU co-legislators in recent years has been to prevent this kind of greenwashing.

Next Steps

The ESAs have stated that the European Commission and themselves will take into account the key takeaways from the Report in order to assess SFDR and to draft level 2 measures, therefore it will be interesting to follow whether the Report will be taken into account.

Regarding deficient disclosures in relation to article 4 (1) (b), the Report mentions that a number of NCAs will follow up individually with the relevant FMPs to inquire the reason for non-compliance, whereas the Report broadly recommends that NCAs should identify FMPs that are not in compliance with article 4 (1) point (a) and (b) and should ensure compliance with these provisions.

It is also interesting to note that the ESAs recommend that NCAs should be equipped to monitor FMPs websites in an automated manner to ensure compliance with the disclosures, which may lead to more monitoring by the NCAs in the future.