A long awaited guidance on the interpretation of major areas of uncertainty
Introduction
In the course of preparation of regulatory technical standards for the Sustainable Finance Disclosure Regulation (SFDR), the European Supervisory Authorities (ESA’s) have identified a number of areas of uncertainty in the interpretation of certain parts of the SFDR. In January 2021, the ESAs have requested some clarification from the European Commission with respect to several priority issues under SFDR that have been seen as major areas of concern for the industry and the regulators across the EU. By a way of response to this request, on 26 July 2021 the European Commission has published its Q&A on the SFDR that provide the answers on queries raised by the ESAs and that are intended to provide some clarity to the financial services industry that is striving to ensure compliance with the new rules.
Application of SFDR to non-EU AIFMs and registered EU-AIFMs
Ever since the publication of the SFDR, one of the main questions that was concerning the fund management industry was whether and to which extent, the new requirements on sustainability related disclosures apply to alternative investment fund managers (AIFMs) located outside the EU. As expected, the Commission has confirmed that SFDR requirements do apply to non-EU AIFMs that market funds into the EU and thereby targeting the EU investors under national private placement regime (NPPR) of the respective EU Member State. Despite industry’s expectation so far, that in this case only the product-related requirements would apply to non-EU AIFMs, the Commission’s response brings some ambiguity to this interpretation, by stating that non-EU AIFMs are expected to ensure compliance with the SFDR including in relation to financial product related requirements. Interpreted broadly, this would mean that non-EU AIFMs may well be required to comply with requirements at entity level as well (publish sustainability risk policy, make website disclosures at entity level etc.). However, this seems like a quite radical approach that would put the non-EU fund managers under excessive regulatory burden. It remains to be seen whether the Commission will provide some further information regarding this important point for the heavily internationalised fund management industry.
One further point that the Commission has addressed in its Q&As is the question whether the SFDR requirements apply to registered AIFMs (AIFMs under the threshold for mandatory authorisation). The Commission has confirmed the common interpretation of this pretty much non-doubtful part of the SFDR by stating that the definition of financial market participants under SFDR is based on the definition of AIFMs within the meaning of Article 4(1) (b) of the AIFMD, which makes no distinction between registered and authorised AIFMs. The AIFMs that are not required under national law transposing the AIFMD, to comply with disclosure requirements (like to publish Art. 23 disclosure statement) will need to include sustainability related disclosures in other documents analogous to pre-contractual and periodic disclosure documents.
Application of the 500-employee threshold for the purposes of PAI reporting to parent companies of large groups
Under SFDR, parent undertakings of large groups (within the meaning of an entity exceeding the thresholds defined by Accounting Directive 2013/34/EU) are required to publish and maintain on their websites a statement, describing their due diligence policies with respect to negative impacts that their investment decisions can have on sustainability factors (principal adverse impact “PAI” statement).
The industry has been grappling for quite some time with the questions whether group’s employees both inside and outside the EU are to be counted towards the 500-employee threshold as defined by the Accounting Directive and whether the PAI statement needs to be made on a group or obliged entity basis.
In its answer, the Commission has stated that all employees of the group, regardless of whether being located inside or outside the EU, are to be counted for the purposes of the 500-employee threshold. On the other hand, when it comes to entities within the group that the PAI statement needs to cover, the Commission clarifies that the PAI statement shall only cover disclosures affecting the relevant financial market participant that is subject to SFDR requirements and not the entire group.
Meaning of “promotion” in the context of the definition of products that promote environmental or social characteristics (commonly known as Article 8 products)
The exact scope of application of additional disclosure requirements for products that promote environmental or social characteristics (Article 8 products) and products that have sustainable investment as objective, has been one of the main issue points for many fund managers that are aiming to ensure compliance with the SFDR. In attempt to provide some clarification as regards the meaning of the term “promotion”, the Commission states that this term basically encompasses any direct and indirect claim, information, disclosures as well as any impression that investments pursued by the financial product also consider environmental or social characteristics in terms of investment policies, goals, targets or objectives. The Commission clarifies that the promotion itself can be made in different ways, including (among other) through the provision of information to investors about the product’s adherence to sustainability-related financial product standards and labels, use of product names or designations (e.g. ESG) or specification of certain sectoral exclusions, regardless of the method used (paper, website, electronic data room etc.).
The Commission’s answer makes it clear that for the promotion of E/S characteristics it is sufficient to present a financial product to prospective investors as a product that considers E/S characteristics in its investment policies, targets and objectives, whereas an active marketing campaign under the specific sustainability label is not necessary. Further, it appears that the Commission has given a clear warning to the industry that inclusion of popular sustainability-related terms in the name and documentation of the financial product will be enough to bring the product under the definition of Article 8 products and trigger the additional disclosure requirements.
On the other hand, the Commission has confirmed that simple integration of sustainability risks is not sufficient for a financial product to be deemed as Article 8 product.
Scope of requirements applicable for Article 9 products
As products that are supposed to have sustainable investment as their objective, Article 9 products have been seen from the beginning as a narrower group of financial products in comparison to Article 8 products, which resulted in them being frequently referred to as “dark green products”. The Commission has now confirmed that Article 9 products generally need to invest in assets that qualify as sustainable investment under Art. 2 (17) SFDR, however they still may invest in other assets (non-sustainable assets) for certain specific purposes, like hedging or liquidity purposes, where minimum environmental and social safeguards under SFDR are met. In the case where an Article 9 product invests in other assets as explained above, the adequate explanation on how the product’s portfolio as a whole is still complying with the sustainable investment objective, needs to be included in product documentation.
Application of SFDR requirements to MiFID portfolios and other tailored products
In its letter from January this year, ESAs have raised few important question of importance for portfolio managers that manage individual portfolios under MiFID II regime. First, Commission has confirmed that the SFDR makes no distinction between the standard set of portfolio management products offered to prospective clients and tailor-made individual portfolio management mandates calibrated in accordance with demands of specific clients (e.g. wealth management clients). An additional question that was concerning the portfolio management industry was the issue of maintenance of client confidentiality in the course of disclosure of sustainability related information under SFDR, that need to be made at individual portfolio level.
The Commission has only stated that portfolio managers are expected to comply with data protection and client confidentiality requirements when making their disclosures under SFDR, by specifying that website disclosures in respect of portfolio management services can also be made at the level of standardised product solutions offered by portfolio managers. This would mean that portfolio managers offering standardised products, can make their website disclosures at the level of a standardised product without coming into jeopardy of disclosing the confidential and personal information protected by applicable laws. On the other side, this clarification can be of great importance for wealth managers dealing with tailor made products, that would have to ensure in the first line the compliance with rules on client confidentiality and data protection (that seem to have a tendency to prevail over regulatory requirements) prior to making website disclosures under SFDR.
Conclusion
The Commission’s Q&A bring a long-awaited clarity to some most debated parts of the SFDR that have been keeping the financial industry (and by far mostly the fund management industry) busy for quite some time now. Despite the fact that certain degree of uncertainty will still remain, the provided clarifications will definitely assist the industry on its way to ensuring the full compliance with the SFDR as the new important milestone is approaching, the start of application of RTS that was recently delayed again, this time until 1 July 2022.
