The Regulatory Technical Standards for the EU Sustainable Finance Disclosure Regulation apply to financial market participants and financial advisers with effect from 1 January 2023. Implementing these requirements presents challenges.
Greater transparency comes at a cost – at the very latest, this should have become clear when the EU Sustainable Finance Disclosure Regulation (SFDR) entered into force. Its aim is to enable retail and institutional investors to understand more easily in future how sustainable the investments underlying a particular financial product are. The SFDR entered into force in March 2021. One-and-a-half years later – on 14 August 2022 – a Commission Delegated Regulation defined the requirements set out in the Regulation in greater detail by introducing Regulatory Technical Standard (RTS), which will come into force at the beginning of 2023.
Standards define the SFDR requirements in greater detail
he RTS define in greater detail the SFDR requirements for the information that must be provided on the impact of investment decisions by financial market participants on environmental, social and employee matters, for example. In particular, the RTS set out indicators for measuring these impacts.
In addition, they further specify the rules governing the information to be provided in pre-contractual documents and periodic reports on financial products. And they give detailed instructions on how this information must be displayed on websites to ensure compliance with the SFDR. The RTS also specify the information that financial market participants should use to demonstrate that the sustainable investments do not significantly harm environmental or social objectives (“do no significant harm” principle).
In this way, the RTS increase the level of detail required for disclosures. In future, investors will be provided with more revealing information about the sustainability of financial products that they can use as the basis for their investment decisions. This is intended to prevent investors who are selecting financial products from getting the wrong impression about, for example, the extent to which their money will flow into sustainable economic activities.
Templates permit comparison
Retail and institutional investors wishing to invest (more) sustainably will in future have a wealth of information at their disposal. To enable them to compare financial products quickly despite this, the RTS contain standardised templates for the product-specific disclosure obligations. These templates can be found in Annexes II to V of the Delegated Regulation. Financial market participants are obliged to use them for financial products which are disclosed under Article 8 or Article 9 of the SFDR. In other words, the rule applies to financial products that promote environmental and/or social characteristics or that have sustainable investment as their objective.
So as not to compromise the objective of the RTS – to allow a quick comparison between financial products – these templates may not be altered. The order in which the information is presented and the position, layout and text of the questions to financial market participants, alongside the infoboxes and graphics, must be identical for all financial products. Financial market participants can only make modifications to the templates to the extent permitted by the instructions for completion (which are given in red type).
A balancing act: comprehensive information in a compact format
The templates are extremely comprehensive, in order to do justice to the objective of achieving the maximum possible transparency. For example, including the instructions for completion, the template in Annex II for pre-contractual information in accordance with Article 8 of the SFDR is five pages long even before it is completed. In other words, financial market participants are faced with the challenge of providing information that is accurate, fair, clear and not misleading on the one hand, and simple and brief on the other.
Financial undertakings themselves should have a keen interest in successfully balancing comprehensive transparency on sustainability and a concise presentation of the information. On the one hand, presentation that is too short or oversimplified runs the risk that consumers at least could gain a misleading impression of, for example, the sustainability impact of a financial product. One potential consequence could be the suspicion of greenwashing – a substantial reputational risk. On the other hand, presentation that is too long may not be sufficiently clear and could therefore also lead to misunderstandings.
Relationship to the sustainability preferences assessment
What does the SFDR have to do with the assessment of clients’ sustainability preferences, which has received a lot of attention in recent months?
Since 2 August 2022, investment and insurance advisory clients have been asked whether they have any sustainability preferences and, if so, what these are. Advisers are only permitted to recommend products that are aligned with the individual client’s specific sustainability preferences (see infobox).
Assessment of sustainability preferences
Since 2 August 2022, investment and insurance advisory clients must be asked about their sustainability preferences. The rules for this are set out in the Delegated Regulation on the Markets in Financial Instruments Directive II and the Delegated Regulation on the Insurance Distribution Directive.
Clients answer the question as to whether and to what extent they wish to invest in a financial product
(1) that contains a minimum proportion of environmentally sustainable investments as defined by the Taxonomy Regulation,
(2) that contains a minimum proportion of sustainable investments as defined by the SFDR, or
(3) that considers the principal adverse impacts on sustainability factors.
In addition, clients specify the minimum proportion of sustainable financial products in the overall investment.
This requires that advisers and clients are able to ascertain from the pre-contractual information a financial product’s level of ambition with regard to sustainability. The assessment of sustainability preferences builds on the information required by the SFDR. Advisers determine suitable products on the basis of the information in the templates.
Minimum requirements versus actual investments
Consequently, a lot of information has to be established during investment consultations. It is therefore all the more important that the pre-contractual information for financial products clearly states whether the financial product in question actually aims to make sustainable investments in the first place. This is achieved using the template in Annex II for financial products for which the information required by Article 8 of the SFDR has to be disclosed additionally. Providers must therefore commit in the pre-contractual information to the minimum proportion of sustainable investments that they are prepared to guarantee to investors (minimum commitment).
What is a sustainable investment?
According to the SFDR, a sustainable investment is an investment in an economic activity that contributes to an environmental or social objective. Further requirements are that the investments do not significantly harm environmental or social objectives and that the investees follow good governance practices.
The Taxonomy Regulation adopts a narrower definition of sustainable investments, as can be seen from the term “environmentally sustainable investment”. The reason for this is that to date only the environmental taxonomy has been completed; the social taxonomy is still outstanding. The criteria for environmentally sustainable investment under the Taxonomy Regulation are also stricter than those contained in the SFDR definition.
By contrast, the extent of sustainable investments actually made is given in the periodic reporting, allowing advisers and investors to compare these figures with the minimum commitment in the pre-contractual information.
Retail and institutional investors therefore also consult the templates and use them as the basis for their investment decisions. This means that retail investors in particular are set to learn a lot in the near future. If they read the pre-contractual information and periodic reporting/the information on the websites carefully, they will quickly be able to independently make environmentally and socially responsible investment decisions.
Data availability – a difficult topic
So much for the theory. In practice, however, financial market participants need a lot of information from the companies in the real economy in which their clients’ money is invested. These data are the only way they can check whether an investment in the company itself or in one of its economic activities corresponds to their financial product’s sustainable objectives. This is a problem, since not enough companies publish such data yet.
As a result, financial market participants have to request the data directly from companies. This becomes difficult if companies don’t yet have the processes in place to collect the data – for example, because they don’t yet comprehensively measure their carbon emissions. At present, only large, capital market-oriented companies with more than 500 employees are required by law to ensure comprehensive transparency on sustainability, and hence to collect such data.
European lawmakers are currently reforming the sustainability reporting requirements for companies and are planning to significantly extend the transparency obligations they are subject to. It is anticipated that these transparency requirements will apply to all large capital-market oriented companies from 2025, and to all small and medium-sized capital-market oriented companies from 2026. Independent external experts will then audit the contents of the sustainability reports. This will significantly expand the volume of reliable data available to financial market participants.
The European Commission, ESAs and BaFin answer questions
BaFin receives a large number of questions from supervised companies about the SFDR (Level 1) and the associated RTS (Level 2). It submits many of these to the Joint Committee of the European Supervisory Authorities (ESAs). The Joint Committee submits Level 1 questions to the European Commission. Level 2 questions are answered by the ESAs via the Joint Committee.
How are the answers to such questions communicated? The European Commission and the ESAs answer the questions by interpreting the statutory requirements and publishing the interpretations in Questions & Answers (Q&As). BaFin contributes to the ESAs’ Q&As in its capacity as a member of the Joint Committee.
The ESAs answered a large number of Level 2 questions in this way in November 2022. The European Commission published Q&As on the SFDR back in July 2021 and May 2022, and the ESAs have already forwarded additional questions to the European Commission. However, it is not always the case that all open issues are resolved in these publications; in some cases follow-up questions arise.
BaFin itself addresses, in particular, national issues and questions of application resulting from the European Q&As, and publishes its opinions on them in its own Q&As. The most recent of this was in September 2022. This included clarification regarding a Q&A issued by the European Commission that is relevant to the question on data availability.
Outlook: review of the RTS planned
The European Commission has mandated the ESAs to provide it with suggested amendments to the RTS. The aim is that it should be clear to investors if and to what extent a financial product invests in gas and nuclear activities that meet the strict conditions set out in the Taxonomy Regulation.
The ESAs have developed corresponding proposals, which were adopted by the European Commission in November 2022 without any major content changes. The European Parliament and the Council of the European Union now have a three-month veto period before the RTS can be officially updated.
The European Commission has also asked the ESAs to further develop the indicators for the information provided by financial market participants that are used to measure the impact of their investment decisions. A particular focus should be on social indicators. With respect to product disclosures, the ESAs are to propose amendments regarding highlighted decarbonisation targets. The ESAs intend to develop additional methods of testing the “do no significant harm” principle.
This means that there is one thing of which financial market participants, advisers and investors can be certain: the RTS, and particularly the templates, will continue to change going forward.
Author
Dana Kubis
Susanne Schenker
BaFin Division ZRC 4
Please note
This article reflects the situation at the time of publication and will not be updated subsequently. Please take note of the Standard Terms and Conditions of Use.
As an expert in financial regulations, particularly in the context of sustainable finance, I bring a wealth of knowledge and hands-on experience to the table. My understanding spans across the European Union Sustainable Finance Disclosure Regulation (SFDR), its Regulatory Technical Standards (RTS), and the practical implications for financial market participants and advisers.
The SFDR, enforced since March 2021, seeks to enhance transparency for investors regarding the sustainability of financial products. The latest development, as of 14 August 2022, introduced the Commission Delegated Regulation defining the RTS in greater detail. These RTS, effective from 1 January 2023, elaborate on the information that financial market participants must provide regarding the impact of investment decisions on environmental, social, and employee matters.
Notably, the RTS establish indicators for measuring these impacts, specify rules for pre-contractual documents and periodic reports, and offer detailed instructions on information display to ensure SFDR compliance. A crucial aspect is the "do no significant harm" principle, for which the RTS provide information to demonstrate that sustainable investments align with environmental and social objectives.
To facilitate quick comparisons for investors, the RTS include standardized templates (Annexes II to V) for product-specific disclosure obligations. Financial market participants must adhere to these templates when disclosing information about financial products falling under Article 8 or Article 9 of the SFDR, which pertain to products promoting environmental and/or social characteristics or having sustainable investment objectives.
Balancing comprehensive transparency and concise presentation is a challenge, as the templates are extensive. However, it is crucial for financial undertakings to provide accurate, clear, and not misleading information. This ensures investors make informed decisions while preventing the risk of greenwashing, which could harm a company's reputation.
The SFDR is also intertwined with the assessment of clients’ sustainability preferences, introduced since 2 August 2022. Advisers must inquire about clients' preferences regarding sustainable investments and recommend products aligned with those preferences. This assessment builds on information required by the SFDR, and advisers use the templates to determine suitable products based on clients' sustainability preferences.
A significant aspect is the definition of sustainable investments, as outlined in the SFDR and the Taxonomy Regulation. Sustainable investments contribute to environmental or social objectives, avoid significant harm, and follow good governance practices. The periodic reporting provides insights into actual sustainable investments, allowing investors to compare them with the minimum commitments stated in pre-contractual information.
Data availability remains a challenge, as financial market participants require information from companies to verify alignment with sustainable objectives. The ongoing reforms in sustainability reporting requirements for companies aim to increase transparency, with a broader scope expected from 2025 onwards.
BaFin, the German Federal Financial Supervisory Authority, plays a crucial role in addressing questions from supervised companies about the SFDR and the associated RTS. Questions are submitted to the Joint Committee of the European Supervisory Authorities (ESAs), and answers are communicated through Questions & Answers (Q&As) published by the European Commission and the ESAs.
Looking ahead, the RTS is subject to review, with the European Commission seeking amendments to ensure clarity regarding investments in gas and nuclear activities meeting strict conditions. The ESAs are also tasked with developing indicators, particularly focusing on social aspects, and proposing amendments related to highlighted decarbonization targets.
In summary, my expertise in sustainable finance regulations allows me to provide in-depth insights into the SFDR, its RTS, and the evolving landscape of sustainable investments in the European Union.
