Following the implementation of the Sustainable Finance Disclosure Regulation (SFDR) in Europe this month, in this article Grania Baird and Kya Fear provide an update on sustainable finance disclosure rules from both a UK and European perspective.
UK Government proposals
In the UK, there has not been a comprehensive onshoring of the SFDR or the Taxonomy Regulation as part of the Brexit process. Instead, in November 2020, the Chancellor set out his ambition for the future of UK financial services and made it clear that he would be positioning the UK at the forefront of green finance. In particular, he announced the introduction of more robust environmental disclosure standards so investors and businesses can better understand the material financial impacts of their exposure to climate change, price climate-related risks more accurately and support the greening of the UK economy.
The Chancellor also announced that the UK will implement its own green taxonomy for determining which activities can be defined as environmentally sustainable. This taxonomy will take scientific metrics in the EU taxonomy as its basis and a UK Green Technical Advisory Group will be established to review these metrics to ensure they are right for the UK market.
The ambition is for the UK to become the first country in the world to make TCFD aligned disclosures fully mandatory across the economy by 2025, going beyond the “comply or explain” approach. A roadmap towards mandatory climate-related disclosures was published alongside the Chancellor’s speech, indicating the timeline of planned or potential regulatory actions or legislative measures over the next five years. Please refer to the timetable at the end of this article which sets out when certain firms are likely to have to comply with these rules.
The FCA has published a Policy Statement and final rule and guidance, requiring UK premium-listed commercial companies to include a statement in their annual financial report which sets out whether their disclosures are consistent with TCFD recommendations, and to explain if they have not done so. This rule applies for accounting periods beginning on or after 1 January 2021 and so the first annual financial reports subject to this rule will be published in Spring next year.
We understand that the FCA will be consulting on mandatory disclosures for pension schemes, insurers and asset managers in line with TCFD in the Summer and that it is also considering publishing a set of guiding principles to help firms with ESG product design and disclosure. These principles are yet to be published but they were mentioned in Richard Monks speech of 21 October 2020 where he said the FCA had 5 areas for potential principles in mind:
|Consistency in messaging and approach||A product’s ESG focus should be clearly stated in its name and then reflected consistently in its objectives, its investment strategy, and its holdings – this about ensuring that a product “does what it says on the tin” and matches consumers’ expectations.|
|A product’s ESG focus should be clearly and fairly reflected in its objectives||Where a product claims to target certain sustainability characteristics, or a real-world sustainability impact, its objectives should set these out in a clear and measurable way.|
|A product’s documented investment strategy should set out clearly how its sustainability objectives will be met||This should include describing clearly any constraints on the investible universe (including any screening criteria and anticipated portfolio holdings). This should also include the fund’s stewardship approach and actions the fund manager will take if investee companies are failing to make the desired progress.|
|The firm should report on an ongoing basis its performance against its sustainability objectives||This is about giving consumers the information they need to understand whether the stated objectives have been achieved in a quantifiable and measurable way.|
|The firm should assure ESG data quality, understand their source and derivation, and articulate clearly and accessibly how it is used||This includes the use of ESG ratings in the investment process.|
Certain aspects of the SFDR came into effect on 10 March 2021, for those firms and products that are in scope.
- By way of reminder, the SFDR applies to firms that are “financial market participants” (FMPs) or “financial advisers” (FAs).
- FMPs include (amongst others) investment firms which provide portfolio management, alternative investment fund managers (AIFMs), UCITS management companies and credit institutions which provide portfolio management.
- FAs include (amongst others) credit institutions, investment firms, AIFMs and UCITS management companies that provide investment advice.
- The products that are in-scope of SFDR include (amongst others) portfolios managed under MiFID II, alternative investment funds, and UCITS.
There are certain outstanding issues relating to the application of SFDR as flagged by the Chair of the ESA’s Joint Committee in a letter to the Commission in January. These outstanding issues include the application of SFDR to non-EU AIFMs and sub-threshold AIFMs, the meaning of “promotion” in the context of Article 8 products (being products that promote environmental or social characteristics), and the application of Article 9 of SFDR (the article that relates to products that have as their investment objective, sustainable investing). The letter also queries the application of the 500-employee threshold for principal adverse impact reporting on parent undertakings of a large group – whether the calculation is applied to both EU and non-EU entities and whether the due diligence statement should include impacts of the parent undertaking or impacts of the group at a consolidated level. It further queries the application of SFDR product rules to portfolios and dedicated funds querying:
- for portfolios or other tailored financial products managed in accordance with discretionary mandates on a client-by-client basis, whether the SFDR disclosure requirements apply at the level of the portfolio only, or whether they can apply at the level of standardised portfolio solutions; and
- if they do apply at the portfolio level, how is it possible to maintain confidentiality obligations to the client in view of disclosures required, such as the website disclosures in Article 10?
We have not yet seen a formal response from the Commission in relation to these queries.
The SFDR level 2 regulations
Alongside the SFDR, there are level 2 regulations setting out the content, methodologies and presentation of certain SFDR disclosures (the RTS). A draft RTS was published in April last year. However, the draft was controversial amongst the financial services industry and its implementation was subsequently delayed, with the Commission noting in a letter to the Chairs of ESMA, the EBA and EIOPA that FMPs and FAs subject to SFDR would still need to comply with its high level and principle based requirements in 2021, even though the accompanying RTS was not complete.
A revised RTS was published in February and a consultation on taxonomy-related sustainability disclosures, which will make further amendments to the revised RTS, followed in March. As it currently stands, the proposed application date of the revised RTS is 1 January 2022 (so the earliest information relating to a reference period to be disclosed in accordance with the RTS would not be made until 2023, giving firms some time to comply with the more granular requirements in the revised RTS).
Although the revised RTS are yet to be adopted and the provisions may evolve, national competent authorities are encouraged to refer FMPs and FAs to the requirements set out in the revised RTS, as a reference for the purposes of applying the provisions of Articles 2a, 4, 8, 9 and 10 of the SFDR in the interim period (see the Joint ESA Supervisory Statement on the application of SFDR published in February).
With respect to the revised RTS, we would highlight the following:
Points to note
|Annex I statement re principal adverse impacts
|Do no significant harm provisions
The policy approach is of minimum standardisation of requirements including mandatory templates, while allowing some tailoring of the approach to the specifics of financial products. Mandatory templates for the pre-contractual disclosures are in the Annexes to the RTS.
For products that promote environmental and social characteristics (so called Article 8 products or “light green” products”), the relevant Annex is Annex II of the RTS (as amended by the Consultation). Headings that will need to be in pre-contractual disclosures include:
For products that have sustainable investment as their objective (so called Article 9 products or “dark green” products), the relevant Annex is Annex III (as amended by the Consultation). Headings that will need to be included in pre-contractual disclosures include:
Please refer to our guide on the SFDR available here for more information.
Looking to the future
There are a number of rules and regulations concerning sustainable finance that are in the pipeline. We have provided a timetable below setting out those relevant to disclosures, which firms may find helpful to refer to.
As noted above, from a European perspective, a number of the provisions of the SFDR are now live and from a UK perspective, the UK is looking to follow suit with mandatory disclosure requirements to be implemented relatively swiftly.
While we await the publication of the FCA’s consultation on mandatory reporting this Summer, it is expected that the UK will follow the principles of the SFDR (although it may depart from the SFDR regarding some of the more granular requirements, such as those set out in the RTS). To that end, UK firms not necessarily subject to SFDR may nonetheless find it helpful to refer to.
We know that firms are also eager to find out when the EU might implement delegated regulations amending provisions under MiFID II which would (per the draft text) require firms, amongst other things, to introduce in their suitability assessment questions that help identify the client’s individual ESG preferences. Unfortunately, at the EU-level there has been silence regarding the implementation of the MiFID II changes and it is not clear when (or if) these will be introduced. In the UK, to date, the FCA has not indicated that it will be bringing in such changes but we await developments.
Mandatory disclosures in line with TCFD for Occupational pension schemes >£5bn, banks, building societies, insurance companies and premium listed companies.
For accounting periods beginning on or after 1 January 2021, UK premium-listed commercial companies are to include a statement in their annual financial report which sets out whether their disclosures are consistent with TCFD recommendations, and to explain if they have not done so.
Possible publication of guiding principles by the FCA for ESG products.
10 March 2021 – a number of the provisions re SFDR came into effect.
30 June 2021 – disclosures under SFDR start being made on firms’ websites.
The Commission is due to publish non-legislative proposals relating to its renewed sustainable finance strategy.
Mandatory disclosures in line with TCFD for occupational pension schemes >£1bn, the largest UK authorised asset managers, life insurers and FCA-regulated pension providers, UK registered companies and the wider scope of listed companies.
1 January 2022 – the revised RTS re SFDR due to come into effect and periodic reporting requirements in SFDR start to apply.
1 January 2022 – disclosure requirements in the Taxonomy Regulation re climate mitigation and adaptation objectives are due to apply.
Mandatory disclosures in line with TCFD for other UK authorised asset managers, life insurers and FCA-regulated pension providers.
1 January 2023 – the disclosure requirements in the Taxonomy Regulation re the remaining environmental objectives are due to apply.
Mandatory disclosures in line with TCFD for other occupational pension schemes (subject to review).
This period will also involve further refinements to measures across categories, including a response to best practice.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.