On the 24th of March 2022, the Joint European Supervisory Authorities (ESAs), has published an updated statement on the application of Level-2 disclosure required under the SFDR and The Taxonomy Regulation (Regulation 2019/2088, the Sustainable Finance Disclosure Regulation, and Regulation 2020/852).
In this article, we will look at what the ESAs statement entails and what are the main takeaways from the update.
Why the ESAs released an updated statement on SFDR and Taxonomy Disclosure
The ESAs include the European Securities and Markets Authority (ESMA), the European Banking Authority (EBA), and the European Insurance and Occupational Pensions Authority (EIOPA). The organization has the objective of supervising the EU financial markets and developing common regulatory frameworks along with the national supervisory authorities of the member states.
The aim of the update is to prevent the “divergent application” of both Regulations in the interim period from 10 March 2021 (the application date of SFDR Level-1 disclosure) to 1 January 2023, the estimated application date of the Regulatory Technical Standards (“RTS”), the so-called “Level-2” disclosure under the SFDR.
The first draft of the RTS was finalized by the ESAs in February 2021, but on the 8th of July 2021, the European Commission (EC) announced its intention to bundle all RTS (including the new provisions introduced by the EU Taxonomy Regulation) in one delegated act to be applied from 1 July 2022. The draft bundled RTS have been submitted by the ESAs in October 2021, but in a later letter, the EC has announced that their application would have been further delayed to the 1st of January 2023.
The required disclosures in the interim period
Let’s now look at the main disclosures that are required by financial market participants (FMPs) in this interim period.
Entity-level disclosure: getting ready for PAIS (Principal Adverse Impacts on Sustainability)
Entity-level disclosure on the consideration of PAIS within investment decisions (art.4 SFDR) has been applying since March 2021 on a comply or explain basis, except for FMPs exceeding the criterion of the average number of 500 employees, whose statement on due diligence policies with respect to those impacts is due since 30 June 2021.
FMPs having published such statements face additional disclosure requirements following art.4 (2) SFDR (currently listed in the draft RTS). On top of extensive qualitative information, FMPs should disclose at least 16 ESG indicators as listed in Annex I. Such additional detailed disclosure is due by 30 June 2023 on the reference period 2022.
Product-level Taxonomy-alignment disclosure: interim clarity or confusion?
The ESAs are clear in stating that the delay of application of RTS to January 2023 does not affect Taxonomy-alignment disclosure, which applies nonetheless starting January 2022. This means that financial products claiming to be article 8 or article 9 compliant, must disclose the share of Taxonomy aligned investments for climate change mitigation and/or adaptation.
The ESAs’ expectation in this interim period is that, in order to comply with TR provisions, FMPs should provide in pre-contractual disclosure an explicit percentage of investments that are Taxonomy-aligned, together with a “qualitative clarification” explaining how the final figure was determined, “for example by identifying the sources of information”. No other information should be provided according to the ESAs. However, this is basically what current articles 8 and 9 pre-contractual templates require, as available within the draft RTS. Website detailed disclosure about the data sources and the methodologies used to calculate Taxonomy-alignment of article 8 and article 9 products, is required starting January 2023 as well.
Challenges and concerns surrounding the ESAs’ statement
What concerns raise doubts, in the market is the ESAs’ assertion that “estimates should not be used”, and that where publicly available data from investee companies are not available, such data should be obtained either directly from investee companies or from third party providers. However, as the Head of Eurosif told Responsible Investor: “They say you shouldn’t rely on estimates, but in practice, we know as long as companies are not reporting the data points, you cannot avoid using some estimates, and therefore data providers”. Furthermore, as he correctly points out, it’s not like data providers have access to sustainability data that “has been hidden from everybody else”, but they are as well relying on their own internal estimates.
It is also hard to reconcile the ESA’s discouragement from the use of estimates with the encouragement of the use of draft RTS in this interim period since articles 40 and 53 explicitly contemplate disclosure about the proportion of data that is estimated for both articles 8 and 9 financial products.
Data challenges are of particularly high magnitude for those investors with large exposures to investee companies not subject to non-financial reporting requirements, such as SMEs and small-mid corporates. Asset managers with significant exposures to private debt will very likely always be in need of good estimates, not currently being well serviced by ESG data providers nor having high leverage on investee companies to require direct additional disclosure.
As the EBA’s Banking Stakeholder Group correctly pointed out in the feedback provided during the public consultation period, the finalized draft RTS fails to adequately integrate the proportionality principle, not envisioning specific provisions depending on FMPs dimensions and type of activity.
ESAs’ updated statement: looking ahead
While the European Commission’s final adopted Delegated Regulation could differ from the current draft RTS, it is important that financial market participants make good use of use 2022 to prepare for the detailed reporting requirements that articles 8 and 9 financial products face starting January 2023.