SFDR

On 6 July 2023, ESMA published the launch of a Common Supervisory Action (“CSA”) in collaboration with NCAs, focused on sustainability-related disclosures and the integration of sustainability risks in the investment fund sector. The aim is to assess whether asset managers comply with the SFDR, the Taxonomy Regulation, and relevant implementing measures, including those related to the integration of sustainability risks.

Through the CSA, the NCAs will work together to promote convergence in supervising sustainability-related disclosures. The key objectives of this initiative are to evaluate the practical adherence of market participants to applicable rules and standards, gather information on greenwashing risks in the investment management sector, and identify appropriate supervisory and regulatory interventions to address the issue.

By ensuring greater convergence in the supervision of incorrect and misleading disclosures, the CSA seeks to enhance transparency in the sustainable finance value chain. The findings from this CSA initiative will also contribute to ESMA's final report on greenwashing, aiding in the identification of potential greenwashing risks at both the entity and product levels.

The next steps involve NCAs conducting their supervisory activities and sharing knowledge and experiences through ESMA to foster convergence in the supervision of sustainability-related disclosures and sustainability risk integration by asset managers.

On 14 July 2023, ESMA published an update to the ESAs’ call for evidence on greenwashing, as reported on previously, with contributions having been accepted until 16 January 2023 and responses now being available.

One may recall that on 15 November 2022, the ESAs initiated a call for evidence on greenwashing, seeking input on potential greenwashing practices within the context of applying the SFDR and gathering information on the scale of greenwashing and identifying areas of high risk for greenwashing.

The ESAs’ call was motivated by the increasing requests for sustainability-related products, the fast-evolving regulation regimes and the related risk of providing investors with misleading or false information about the environmental impact of the offered investments.

On 9 June 2023, the European Commission issued a draft Delegated Act on European Financial Reporting Standards (EFRS) (the “Draft Delegated Act”). The Draft Delegated Act has raised some uncertainties. In this respect, on 12 July 2023, the Sustainable Finance Advisory Group (SMSG) provided advice on sustainable finance matters to the ESMA.

First, there are diverging opinions within the SMSG regarding the inclusion of new social principal adverse impact (PAI) indicators. Some argue for their inclusion as of now, while others believe it is preferable to wait until legislative inconsistencies in the Draft Delegated Act are resolved. Regarding the quantitative PAI thresholds, the SMSG supports the mandatory disclosure of quantitative PAI thresholds where they are used by financial market participants. Nonetheless, the SMSG admits that setting quantitative thresholds for every PAI indicator is impractical.

There are also diverging opinions within the SMSG concerning the treatment of derivatives. Whereas the majority prefers an approach where the exposure to sustainability is considered when dealing with derivatives, a part of the group thinks that derivatives should not be included in sustainability reporting.

The inclusion of hyperlinks to benchmark disclosures for products focused on greenhouse gas (GHG) emissions reduction are deemed useful, as it is general information on the choice for a specific benchmark.

As regards the Paris agreement, the suggestion to disclose the degree of alignment with the requirement set out in this agreement in the pre-contractual disclosures is considered valuable by the SMSG for products focused on GHG reduction, with a focus on real and effective reductions rather than carbon credits. The SMSG also emphasises that since the GHG Protocol's standards are popular, alternative standards should not be prohibited.

Finally, the SMSG expresses its concerns about the costs and practical challenges regarding the reporting requirements, particularly for investee companies and financial market participants.

On 12 July 2023, ESMA shared its up-to-date sustainable finance implementation timeline. Looking forward, the next steps are:

• 1 January 2024: Corporate Sustainability Reporting Directive (“CSRD”) applies to companies currently subject to Non-Financial Reporting Directive (“NFRD”). Financial undertakings start disclosing the full key performance indicators on taxonomy alignment under Art 8 Taxonomy Regulation Delegated Act on transparency of undertakings in non-financial statements
• 30 June 2024: Second Financial Market Participant Principal Adverse Impact statement under SFDR Delegated Regulation
• 1 January 2025: CSRD applies to all large undertakings
• 1 January 2026: CSRD applies to listed SMEs and small & non-complex financial institutions on an optional basis
• 1 January 2028: CSRD applies to third country companies and listed SMEs/small financial institutions

On 3 August 2023, the CSSF issued a thematic review on the implementation of SFDR within the AIFMD requirements providing further guidance to financial market participants and financial advisors through this ESG journey regarding (i) organisational arrangements of AIFMs, including the integration of sustainability risks, (ii) compliance of precontractual disclosures, including product website disclosures, (iii) compliance of periodic disclosure information, (iv) investment fund documentation and marketing communications, and (v) investment portfolio analysis.

(i) Organisational arrangements of AIFMs, including the integration of sustainability risks

• Delegation to third party: The CSSF reminds that the AIFMs are still responsible for the delegation of any of its functions to third parties, including for the SFDR disclosure requirement, meaning that cross references must be made from the AIFM’s website to the relevant website where all relevant information pursuant to Article 10 of SFDR is made available.
• Risk management framework: The CSSF expects AIFMs to address and cover in their risk management and internal governance processes all relevant sustainability risks that could cause an actual or a potential material negative impact on the value of an investment.

(ii) Compliance of precontractual disclosures, including product website disclosures

Disclosure of environmental/social characteristics or sustainable objectives: AIFMs shall provide information required by SFDR in a manner that is easily accessible, non-discriminatory, prominent, simple, concise, comprehensible, fair, clear and not misleading for investors.

• Fund names: Investment funds’ names should not be misleading. ESG-related terms should be used only when supported in a material way by evidence of sustainability characteristics, themes or objectives that are reflected fairly and consistently in the fund’s investment objectives and policy and its strategy as described in the relevant fund documentation.
• Definition of sustainable investment: The CSSF expects AIFMs, after having carried out their own assessment of sustainable investments, to disclose the underlying assumptions used.
• Fund asset allocation: The CSSF expects the asset allocation disclosed to be aligned and comprehensive with regard to the environmental/social characteristics promoted by the fund or the sustainable investment objective pursued by the fund.
• Consideration of PAI at financial product level: AIFMs should provide, in the precontractual disclosures, for each financial product a clear and reasoned explanation of whether and, if so, how a financial product considers the PAI on sustainability factors, including references to the procedures put in place to mitigate those impacts.
• Product website disclosures: It is required that financial market participants to publish and maintain on their websites information for each investment fund disclosing under Article 8 or 9 of SFDR and for each financial product, publish this information in a separate section titled “sustainability-related disclosures”.

(iii) Compliance of periodic disclosure information

• Realisation of ESG characteristics/sustainable investment objective: The CSSF reminds AIFMs that the annual report setting out that information on the environmental/social characteristics should provide the sustainability indicators used, the limitations defined in precontractual disclosures for these indicators (if any) and a quantitative assessment of these indicators realised during the period.
• Information to be provided on PAI on sustainability factor: In this context, the CSSF expects AIFMs to provide, where applicable, for each investment fund concerned, sufficiently detailed and relevant information on the PAI considered during the period, taking into account the qualitative and/or quantitative information set out in the precontractual disclosures.

(iv) Fund documentation and marketing communications

The CSSF reminds that AIFMs are required to ensure that their marketing communications do not contradict the information disclosed pursuant to SFDR and shall not be limited to general descriptions or use of hyperlinks.

(v) Portfolio analysis

The CSSF expects AIFMs to take account, for the investment funds disclosing under Article 8 or 9 of SFDR, of the provision that a financial product may, next to “sustainable investments”, also include investments for certain specific purposes, such as hedging or, relating to cash, as ancillary liquidity, provided that those investments are in line with the sustainable investment objective of the product.

On 1 September 2023, the association of the Luxembourg fund industry (“ALFI”) issued its statement in response to the European Commission’s consultation regarding the proposal for a regulation on the transparency and integrity of environmental, social, and governance (“ESG”) rating activities (the “Proposal”). The objective of this Commission initiative was to seek input from stakeholders on the Proposal with the aim of improving the quality, reliability and comparability of ESG ratings to enable investors to make better informed investment decisions in regard to sustainability objectives.

ALFI generally expressed its support of the overarching objective of enhancing the transparency, reliability and comparability of ESG rating and ESG data products, to foster trust and confidence in the operations of ESG rating providers for the investment management industry and for the end-investors. Further to this, ALFI issued the following comments and suggestions:

(i) ALFI expressed concern about the necessity of clear exemptions within the Proposal, which should cover ESG ratings shared within a corporate group, internal ESG assessments for internal use by asset managers and funds, and ESG ratings or data products used in compliance with existing EU regulations such as SFDR and MIFID II. This exemption should also cover proprietary assessments used for investment research products.

(ii) ALFI suggested that ESG data products developed for commercial purposes, as well as raw ESG data, should be included within the Proposal’s scope. Transparency in methodology and data selection is crucial to mitigate greenwashing risks.

(iii) ALFI underscored the critical need for aligning the definitions and scope of ESG rating and data products with those outlined in the International Organization of Securities Commissions’ report on ESG rating providers and ESG data product providers.

(iv) ALFI supported the Proposal's promotion of transparency and recommends that in the forthcoming Regulatory Technical Standards, ESG rating providers should disclose the origin of data points and provide detailed descriptions of their methodologies and assumptions.

(v) Regarding fees, ALFI urged enhanced transparency, ensuring that users of ESG rating and data products receive clear information about sources, timestamps, fees, and pricing drivers.

(vi) ALFI suggested including "Taxonomy alignment" in Annex III of the Proposal, specifying the minimum alignment percentage disclosure. This would benefit passive funds and enhance clarity in this regard.