ESMA publishes SFDR final rules
ESMA’s previous draft RTS provoked industry’s concerns due to the complexity and onerousness of the requirements. ESMA has sought to address some of the feedback that it received last year. The final report provides changes to the draft rules and clarifies the likely timeline for implementation.
Entity-level disclosures
From 10 March 2021, asset managers will be required to publish a sustainability risk policy and to decide whether to publish a due diligence statement about how its investment decisions affect sustainability factors. The due diligence statement requires firms to determine the principal adverse impacts of its investments and to disclose how it seeks to mitigate those adverse impacts. The due diligence statement will become mandatory for large asset managers from 30 June 2021. However, asset managers that have fewer than 500 employees will be able to opt out of disclosing principal adverse impacts.
ESMA’s earlier RTS detailed 50 environmental and social metrics for principal adverse impact reporting, comprising 32 mandatory metrics and 18 opt-in metrics. The revised RTS address the balance between mandatory and opt-in metrics.
ESMA has divided the mandatory metrics into 14 for investee companies, two for sovereigns and supranationals and two for real estate assets. There are a further 33 opt-in metrics for investee companies, seven for sovereigns and supranationals and five for real estate assets. In addition, the disclosure template gives greater prominence to firms’ actions taken in respect of each principal adverse impact to better demonstrate its mitigation.
Asset managers will welcome the reduced mandatory reporting burden, which will ease the challenge of sourcing sufficient data to report under the metrics, although the changes do not go quite as far as the six mandatory metrics that many had asked for. However, a high level of transparency will be expected. Firms will need to opt-in to additional reporting metrics if they are relevant to its investments and will also need to produce a qualitative description of the principal adverse impacts, relevant policies, conformance with international standards and a historical comparison. Furthermore, managers must determine whether and how each of their products (and not only ESG products) are relevant to the principal adverse impacts and to make product level disclosures accordingly.
Product-level disclosures
Asset managers will be required to make pre-contractual disclosures for ESG products (that is, Article 8 or "light green" funds and Article 9 or "dark green" funds). ESMA notes the challenge of preparing a single set of rules on pre-contractual disclosure for a wide range of products, with disclosure documents that vary from short key information documents to longer prospectuses. Consequently, the RTS provides minimum requirements that apply to all in-scope ESG products. While it is only a minimum, the RTS does continue to remind asset managers not to excessively disclose on sustainability which could result in misleading investors. The SFDR also requires managers to produce website and periodic disclosures for their ESG products. The revised RTS makes changes to the format and order of the disclosures rather than the contents.
Timing
The European Commission (EC) is expected to adopt the RTS by early May 2021. While firms must implement many of the SFDR level 1 provisions by 10 March 2021, the EC will decide a later application date for the RTS. ESMA proposes 1 January 2022. If ESMA’s proposed timeline is upheld, periodic reporting of ESG fund performance against the relevant principal adverse impacts will begin in June 2023 with reference to 2022 as the first performance year. The reference period has changed to five years rather than 10 years in the previous draft RTS.
ESMA will publish a supervisory statement before the RTS are implemented to encourage consistent adoption and application of the rules across member states. ESMA will also issue a consultation on related disclosures to be made under the Taxonomy Regulation.
Finally, ESMA recently requested that the EC provide further guidance on several areas of the SFDR, including on the classification of Article 8 and Article 9 funds, which will be relevant to how firms interpret and implement the rules. While further guidance on fund classification would be helpful, it is not guaranteed that the EC will provide more information. Ultimately it will be for the market to set the parameters, not least given the wide range of ESG strategies that are potentially in scope.
