ESG Regulation Monthly Round-Up

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ESG Regulation Monthly Round-Up - July 2022

01 July 2022

With so many developments across the globe in the area of sustainability-related disclosures, we have looked back throughout May 2022 and summarised the key points coming out of the EU, UK and US.

ESAs further questions to the EC and responses

In December 2021 (although published in May 2022), the ESAs submitted to the EU Commission (“EC”) further queries relating to the interpretation of the SFDR and the Taxonomy Regulation (“TR”). A summary of the key questions for FMPs, along with the EC’s responses (published by ESMA on 25 May 2022), is set out below.

ESAs Question	EC Response	Comments
Principal adverse impact disclosures: whether an FMP that opts out of PAI disclosure at the entity level can still indicate that they consider PAIs under article 7?	The EC has confirmed that it is possible to consider PAIs at the product level, even if an FMP does not consider PAIs at the entity level.	Many FMPs consider PAIs at the product level without complying with Article 4, and indeed Article 9 products (and Article 8 products with “sustainable investments”) need to consider the PAIs as part of the “do no significant harm” test in any case. As such, this response is helpfully in line with the approach that has been adopted by the market to date.
Pre-contractual risk and PAI disclosures for products no longer made available: do the sustainability risk and PAI product level disclosures apply only to new financial products or also to products that existed as of the SFDR’s application date on 10 March 2021?	The EC has confirmed that for existing financial products that were no longer made available to end investors as of 10 March 2021, FMPs did not need to comply with the pre-contractual disclosures but they must comply with the: periodic reporting requirements under Article 11; and website disclosures under Article 10.	This decision is consistent with the view adopted by the market; pre-contractual disclosure requirements do not apply to existing closed products but periodic reporting and website requirements do apply. This will only bite on Article 8 and 9 products given that Articles 10 and 11 do not extend to Article 6 products. However, this also means that the EC expects FMPs to have undertaken a categorisation exercise of all in-scope products, including those that were not made available to new investors as of 10 March 2021. New raisings for any funds that were in a closed period as of 10 March 2021 will require SFDR-compliant pre-contractual disclosures. Again, this is consistent with the view that has been adopted by the market.
Scope of Articles 5 and 6 TR disclosures: do Article 8 SFDR products that do not invest in any “sustainable investments” need to make disclosures under Article 6 TR? Do Article 9 SFDR products with a social objective still need to disclose under Article 5 TR where it subsequently makes environmental sustainable investments?	Article 8 SFDR / Article 6 TR products The EC has confirmed that FMPs must make disclosures under Article 6 of the TR for all Article 8 SFDR products that promote environmental characteristics, whether or not they invest in economic activities that contribute to an environmental objective (i.e. “sustainable investments” as defined in Article 2(17) SFDR). Article 9 SFDR / Article 5 TR products The EC has confirmed that FMPs must make disclosures under Article 5 TR where an Article 9 SFDR product that initially commits to a social objective in its pre-contractual disclosures subsequently invests in economic activities contributing to an environmental objective. Data As a reminder, FMPs are required to use reliable data to disclose how and to what extent the investments underlying the financial product are in economic activities that qualify as environmentally sustainable under Article 3 TR. The ECs have: confirmed that where FMPs fail to collect such data, the precontractual and periodic product-related disclosures must indicate zero TR-alignment; and reiterated that in exceptional cases where FMPs cannot reasonably obtain the relevant data to determine TR-alignment, they can perform complementary assessments and estimates based on information from other sources, but only to only compensate for limited and specific parts of the desired data elements.	This is inconsistent with: the views previously expressed by the ESAs that such disclosures were not required for Article 8 products if they do not invest in economic activities that contribute to an environmental objective (i.e. “sustainable investments” as defined in Article 2(17) SFDR); and the structure of the template Annex for Article 8 disclosures suggests that TR-alignment disclosures are only necessary for Article 8 SFDR products that make sustainable investments. We will be monitoring to see how the market responds to these inconsistencies.

ESAs Question

EC Response

Comments

Principal adverse impact disclosures: whether an FMP that opts out of PAI disclosure at the entity level can still indicate that they consider PAIs under article 7?

The EC has confirmed that it is possible to consider PAIs at the product level, even if an FMP does not consider PAIs at the entity level.

Many FMPs consider PAIs at the product level without complying with Article 4, and indeed Article 9 products (and Article 8 products with “sustainable investments”) need to consider the PAIs as part of the “do no significant harm” test in any case. As such, this response is helpfully in line with the approach that has been adopted by the market to date.

Pre-contractual risk and PAI disclosures for products no longer made available: do the sustainability risk and PAI product level disclosures apply only to new financial products or also to products that existed as of the SFDR’s application date on 10 March 2021?

The EC has confirmed that for existing financial products that were no longer made available to end investors as of 10 March 2021, FMPs did not need to comply with the pre-contractual disclosures but they must comply with the:

periodic reporting requirements under Article 11; and
website disclosures under Article 10.

This decision is consistent with the view adopted by the market; pre-contractual disclosure requirements do not apply to existing closed products but periodic reporting and website requirements do apply. This will only bite on Article 8 and 9 products given that Articles 10 and 11 do not extend to Article 6 products. However, this also means that the EC expects FMPs to have undertaken a categorisation exercise of all in-scope products, including those that were not made available to new investors as of 10 March 2021.

New raisings for any funds that were in a closed period as of 10 March 2021 will require SFDR-compliant pre-contractual disclosures. Again, this is consistent with the view that has been adopted by the market.

Scope of Articles 5 and 6 TR disclosures: do Article 8 SFDR products that do not invest in any “sustainable investments” need to make disclosures under Article 6 TR?

Do Article 9 SFDR products with a social objective still need to disclose under Article 5 TR where it subsequently makes environmental sustainable investments?

Article 8 SFDR / Article 6 TR products

The EC has confirmed that FMPs must make disclosures under Article 6 of the TR for all Article 8 SFDR products that promote environmental characteristics, whether or not they invest in economic activities that contribute to an environmental objective (i.e. “sustainable investments” as defined in Article 2(17) SFDR).

Article 9 SFDR / Article 5 TR products

The EC has confirmed that FMPs must make disclosures under Article 5 TR where an Article 9 SFDR product that initially commits to a social objective in its pre-contractual disclosures subsequently invests in economic activities contributing to an environmental objective.

Data

As a reminder, FMPs are required to use reliable data to disclose how and to what extent the investments underlying the financial product are in economic activities that qualify as environmentally sustainable under Article 3 TR. The ECs have:

confirmed that where FMPs fail to collect such data, the precontractual and periodic product-related disclosures must indicate zero TR-alignment; and
reiterated that in exceptional cases where FMPs cannot reasonably obtain the relevant data to determine TR-alignment, they can perform complementary assessments and estimates based on information from other sources, but only to only compensate for limited and specific parts of the desired data elements.

This is inconsistent with:

the views previously expressed by the ESAs that such disclosures were not required for Article 8 products if they do not invest in economic activities that contribute to an environmental objective (i.e. “sustainable investments” as defined in Article 2(17) SFDR); and
the structure of the template Annex for Article 8 disclosures suggests that TR-alignment disclosures are only necessary for Article 8 SFDR products that make sustainable investments.

We will be monitoring to see how the market responds to these inconsistencies.

EC mandate to ESAs to propose amendments to the RTS

The EC has issued two (2) letters to the ESAs requesting that they propose amendments to the:

the RTS in relation to PAI indicators by extending the lists of indicators and refining the content of all the indicators and their definitions, applicable methodologies, metrics and presentation. This is an unhelpful request given that the RTS is not yet in force and any amendments could ultimately require FMPs to make changes (hopefully not fundamental ones) to their approach to compliance, increasing what is already a burdensome requirement. However, the EC has confirmed that this request will not affect the implementation of the current RTS from 1 January 2023 and so any changes will not be imminent. The ESAs need to submit a new draft RTS by April 2023;
information that should be provided in pre-contractual documents, on websites, and in periodic reports about the exposure of financial products to investments in fossil gas and nuclear energy activities. The amendments shall ensure that the disclosures provide for full transparency about such investments for compliance with the Complementary Climate Delegated Regulation. Perhaps this request for enhanced disclosures should not be surprising given that the inclusion of gas and nuclear activities is controversial and several member states strongly objected.

FCA SDR, investment labels and Taxonomy

SDR and investment labels: While the FCA had anticipated publishing its draft rules on sustainability disclosure requirements (“SDR”) and investment product labels in Q2 of this year, the May 2022 Regulatory Initiatives Grid (“Grid”) provides that the FCA will publish a consultation paper with draft rules by July 2022. The Grid confirms that formal engagement is planned between October and December. As such, there still appears to be some way to go before we have a final set of rules and are able to determine the impact that the FCA’s SDR will have on managers who are currently complying with the SFDR.
UK green taxonomy: Similar to the EU’s approach to developing technical screening criteria, the UK is going to publish the Technical Screening Criteria (“TSC”) in tranches, with the first two TSCs relating to Climate Change Adaptation and Climate Change Mitigation to be finalised by the end of 2022. The remaining four TSCs are to be finalised by end-2023 – although this date is under revision.

SEC proposals

In order to help prevent “greenwashing”, the SEC (i.e. the U.S. regulator) has published two new proposals aimed at investment funds that take into account ESG factors as follows:
- Names Rule – if a fund’s name suggests a focus on ESG factors, it would be required to invest at least 80% of its holdings in such assets. A fund that merely considers ESG factors alongside, but not more than, other inputs would not be permitted to use ESG or related terms in its name.
- Disclosures – funds that consider ESG in their investment processes would be required to disclose how they measure progress toward that goal. Additionally, funds for which ESG investing is a significant or primary consideration would be required to fill out a standardised table as well as additional information about the greenhouse-gas emissions produced by the companies or issuers in their portfolios.