Published: 27 Sep 2022 · Last updated: 15 Oct 2023
*On the 4th of December, the European Supervisor Authorities published a report containing proposed amendments to SFDR’s regulatory technical standards.
The proposals are:
The European Commission will now take until March 2024 to decide on the proposals. To find out more, read the report or contact a member of our team. The information in this article is up to date as of December 2023.
We're rounding off our SFDR Blog with an overview of the most frequently asked questions we've encountered over the course of this series.
Our previous blogs have introduced the Sustainable Finance Disclosure Regulation (SFDR) and the Principal Adverse Impact Indicators (PAIs). We've discussed the difference between Article 8 and Article 9 funds, and we've talked about how SFDR links with the EU Taxonomy. In this final blog of the series, we'll be running through some of the questions we're often asked with regard to SFDR. We'll also explain what the SFDR will mean for fund managers in the future.
Since the publication of the original SFDR legislation, there have been multiple updates. These updates have sought to add further clarification to the original document, adding the technical detail required to enable fund managers and their portfolio companies to comply.
The European Commission has also published two Q&As, one in May 2021 and another in July 2021. These documents reflect the amount of confusion that some of these publications have caused. The questions below touch upon some of these topics. We also address some of the more recent points of confusion that have emerged since the final version of SFDR regulation was published in April 2022.
It's ultimately up to the fund manager to decide whether a fund should be classified as an Article 6, Article 8, or Article 9 fund. The regulation makes it clear that SFDR is not a “labelling regime”. It is the composition of the portfolio that will largely determine the appropriate product classification. If the fund is still being formed, then the fund manager may choose a particular investment approach, or they may align the investments with certain environmental or social characteristics in order to attain Article 8 or 9 classification.
However, if the fund is already formed, it is unlikely that it can be classified as Article 8 or 9 unless it has already been classified as an “impact fund” or equivalent. It is worth noting that product classification goes beyond the fund composition, as it encapsulates firm-wide commitments and policies. Fund managers should note that, even though there have not yet been sanctions associated with misclassifying funds, the investment community has already begun to disregard certain Article 8 funds if they do not meet the required standards.
For further information on what constitutes an Article 6, 8 or 9 fund, take a look at our article on Article 8 vs Article 9 Classification.
The short answer to this question is quarterly.
The legislation clearly states that the PAIs should be “end of year calculations based on the average of at least four quarter-end calculations” (i.e., March 31st, June 30th, September 30th, 31st December).
However, as noted by the German investment advocacy association, BAI, some of the PAIs (e.g., exposure to controversial weapons) are relatively fixed and do not change through the investment cycle of an asset. This begs the question as to whether or not it is practical to report on all values every quarter.
Regulators accept that data may not be available every quarter for select PAIs. They have provided a worked example for the GHG emissions PAI, where an annual emissions value is used for the quarterly calculations, and the % holding quarterly values affect the final weighting. It is therefore okay to not have quarterly data for all PAIs, particularly in the first round of reporting based on 2022 data.
The regulators have accounted for this scenario as well. There are other ways of providing the relevant information:
These methods can only be used when it has been made clear that “best efforts” have been made to find the relevant information.
These best efforts must be evidenced in disclosures by the fund manager. This evidence is required to ensure that fund managers make an effort to source the primary data.
Concerns have been raised by the Securities and Market Stakeholder Group that, particularly in the early rounds of reporting, it is unlikely that data will be directly available from investee companies. This could lead to a reliance on third-party data firms, who will rush to provide the appropriate information. This rush may compromise the reliability of the information provided and the robustness of the associated methods used to collect the relevant data.
The PAIs are required across multiple areas of SFDR regulation, as they are the core set of metrics that reinforce the overall aim of the regulation - to eliminate greenwashing from the financial sector.
They are required under Article 2(17) to prove that a sustainable investment “does no significant harm” to any environmental or social sustainable investment objective. This applies to all Article 9 funds and select Article 8 funds (i.e., Article 8+ funds).
Articles 4 and 7 require a statement from the fund manager with regards to whether they have considered the principal adverse impact on sustainability factors at a firm-level and fund-level respectively. Finally, the PAIs may be used in Articles 10 and 11 to support the measurement of environmental/social characteristics for Article 8 funds, or the measurement of sustainable investment objectives for Article 9 funds.
When the full list of PAI indicators were released in 2021, concerns were expressed by various relevant stakeholders, including consumer representative organisations, NGOs, and public sector authorities. These stakeholders were concerned about the length and technical detail of the templates containing the PAIs.
They felt that investors might be overwhelmed with the sudden requirement to disclose an unprecedented volume of portfolio-level data, when there had been no prior requirement to do so. Despite these concerns being raised in consultations, there have only been minor changes to certain definitions and calculations.
Given that the first PAI report is due by June 2023, it is unlikely that there will be an overhaul of the PAIs at this point. However, this cannot be ruled out for future reporting periods.
Given the structure of core and additional indicators, the core list of mandatory PAIs may be expanded. It might include more of the additional indicators, only one of which is currently required for environment and social/governance sections respectively.
For further information on what are the core and additional PAI indicators, take a look at our detailed list for investee companies and real estate assets
Since the legislation was first published in March 2019, there has been a general lack of publications available online offering insight on what the regulations mean for investors and fund managers.
This is largely because the rulings have not yet been fully enforced. More recently, however, with the first SFDR report containing the PAIs due by June 2023, several industry associations have begun to publish useful overviews of the regulation. Many have been reflecting on what is considered best practice to date.
These publications are currently limited, making it difficult to reflect on standard practices or interpretations. Below are two papers that our experts believe summarise the topic well:
Our own SFDR series is another useful resource to use, as each article summarises the key takeaways for each topic. Links to each article can be found below:
Of course, if you have any further questions, please don’t hesitate to reach out to our team. We'd be happy to answer any query you might have - big or small.