Eu funds and fund managers – Firm-related disclosures

Sustainability risk policies¹

All firms in scope of the SFDR must publish information about their policies on the integration of “sustainability risks” in their investment decision-making process.

A “sustainability risk” is an environmental, social or governance event or condition that, if it occurs, may negatively affect the value of an investment. A sustainability risk is a type of financial risk that firms may be expected to consider in the course of their investment decision-making, to the extent relevant to the investment strategy.

Many private equity sponsors have satisfied this disclosure obligation by publishing elements of their responsible investment policy and demonstrating that they consider sustainability risks (such as climate risks) as an investment risk, typically with a longer-term impact.

Under the SFDR, firms must include in their remuneration policies information on how those policies are consistent with the integration of sustainability risks, and publish that information on their websites.

EU-authorised AIFMs are required to integrate sustainability risks into their portfolio and risk management functions. This integration will feed into the related disclosures made under the SFDR. ESMA’s supervisory briefing of May 2022 on best practices for disclosures under the SFDR includes guidance (directed at national competent authorities) on how fund managers can integrate sustainability risks, stating that competent authorities could review managers’ integration of sustainability risks into investment due diligence, risk management, remuneration, HR, governance, internal reporting and record-keeping, conflicts of interest, delegation monitoring, accounting and valuation, costs and fees and internal control functions.

From 1 August 2022, EU-authorised AIFMs are required to integrate sustainability risks into their portfolio and risk management functions.

Principal adverse impact factors²

The SFDR distinguishes between value-related “sustainability risks” and the broader concept of consideration of the “principal adverse impacts of investment decisions on sustainability factors” (“principal adverse impacts” or “PAI factors”).

Principal adverse impacts are the potentially harmful impacts of a firm’s investment decision on a range of environmental, social and governance matters.

While firms may take into account “sustainability risks” as part of their normal investment process, the same may not be true for wider societal impacts that do not have significant implications for the investment’s value. Firms, other than those which can and have opted out of the regime, are required to give information on their website on how their due diligence policies incorporate these factors, taking into account the firm’s size, nature and scale of its activities and the types of financial products it makes available. Most private equity and venture capital firms will be able to opt out as they will fall below the 500-employee threshold.

A firm within scope of this obligation must include (and keep up to date) the following in its website disclosure:

its policies on the identification and prioritisation of the principal adverse sustainability impacts and indicators;
a description of the principal adverse sustainability impacts and any mitigating actions taken or, where relevant, planned;
summaries of engagement policies with listed companies, where applicable; and
its adherence to responsible business conduct codes and internationally recognised standards for due diligence and reporting that are adhered to and, where relevant, the degree of alignment of the firm with the targets of the Paris Climate Agreement.

From 1 January 2023, firms are required to use the template in the RTS to provide information on the principal adverse impacts of their investment decisions on sustainability factors.

This information must be provided in the form of the template “Statement on principal adverse impacts of investment decisions on sustainability factors” in the Level 2 Regulatory Technical Standards (Annex 1).

The template includes a narrative summary section which must be provided in English, an official language of the home Member State of the firm (if different) and an official language of each Member State where a product of the firm is made available.
The template in “Table 1” sets out 14 mandatory environmental and social “adverse sustainability indicators” for investments in “investee companies” and defines the metric that firms must apply in obtaining information about the indicators, with firms reporting the “impact” each year with a description of any actions taken or planned, and targets set for the next period, in respect of each indicator (see Annex I). The template also includes a separate and shorter set of indicators applicable to investments in sovereigns and supra-nationals and investments in real estate assets, which a firm should use in substitution for the indicators for “investee companies”.
Tables 2 and 3 of the template include additional environmental, social and governance indicators (for investments in investee companies, sovereigns, supra-nationals and real estate assets), with firms required to choose at least one additional factor from each of Tables 2 and 3 and potentially more if those additional indicators are regarded as material to their investments. As part of the disclosure, firms will be required to describe the methodology used to select these additional indicators.

The ESAs published a consultation paper in April 2023 that proposed to extend the list of social indicators for PAIs, in part to align the indicators to the information to be reported by companies under the first set of draft ESRS under the CSRD, and improve the definitions, methodologies, metrics and presentation for various PAI indicators.

The ESAs published clarifications on the ESAs’ draft RTS under SFDR in June 2022. This includes guidance on calculating PAI factors, including how impact is assessed for CO₂emissions on a quarterly basis, and guidance on the principle that PAI indicators should be assessed on a look-through basis (looking through funds (for funds of funds), holding companies and SPVs). There is also guidance on specific PAI indicators, including in relation to indicator 14 (identification of human rights issues), which states that firms could refer to, for instance, the Charter of Fundamental Rights of the European Union. The ESAs also published Q&As in November 2022 which contain further guidance on calculating and reporting PAI factors, including disclosure of the proportion of investments for which the financial market participant has relied on data obtained from investee companies or other sources and guidance on assessing specific indicators. Further Q&As were published in April 2023 with additional guidance on calculating and reporting PAI.

Should a firm consider all PAI factors?

Inevitably, firms will regard some PAI factors as more relevant for a given strategy than others, and the data underlying some PAI factors is easier to collect than others. However, there are no clear grounds in the SFDR for a firm to disregard any of the mandatory indicators that it considers are not relevant or material or where the data is difficult to collect.

There are no clear grounds in the SFDR for a firm to disregard any of the mandatory indicators that it considers are not relevant or material or where the data is difficult to collect.

In terms of guidance as to how firms should approach data gaps, the Level 2 Regulatory Technical Standards require firms, where information relating to indicators is not readily available, to use best efforts to obtain the information from investee companies or to carry out additional research, co-operate with third party data providers or external experts or make reasonable assumptions.

What is the timing for publication of information relating to PAI factors?

Firms must publish the “Statement on principal adverse impacts of investment decisions on sustainability factors” on their website by 30 June in each year, with the information disclosed covering the prior calendar year (the “reference period”).

Firms must obtain, at a minimum, quarterly “snapshots” of information on the indicators, according to the metric specified, and publish the average of those figures for the reference period. The requirement to obtain information on a quarterly, as opposed to annual, basis may in practice entail a large amount of work for firms.

Firms must publish their PAI statement on their website by 30 June in each year, with the information disclosed covering the prior calendar year.

Can a firm opt out of considering PAI factors?

The SFDR contemplates PAIs applying at firm level under Article 4 and separately at product level under Article 7.

Application at product level is addressed in this section. Firms that do not consider such factors will need to explain, by a statement on their website, that this is the case; give clear reasons for not doing so; and indicate if and when they intend to consider such factors. However, large firms (which are firms that exceed an average number of 500 employees during their financial year, or firms that are parent undertakings of a “large group”³which exceeds an average number of 500 employees⁴ during their financial year), cannot benefit from the “comply or explain” option.

What does ongoing reporting of PAI factors require?

Reporting PAI factors requires systematic assessment of ESG in underlying portfolio companies, in principle prior to acquisition and on an ongoing basis, requiring engagement of external providers and analysts in the due diligence process.

The information required for the various indicators will not be publicly available for many investee companies. Firms in scope of PAI reporting are using best efforts to obtain the data, but it will be some time before firms have systems in place to get hold of data that is complete and reliable. With respect to the possibility for firms having opted out of PAI disclosure to provide PAI reporting for certain of their fund products, please see the “Principal adverse impacts” section under Fund-related disclosures.

What does “considering” PAIs mean, and does PAI reporting limit a firm’s investment discretion?

PAI reporting under the SFDR requires a firm to “consider” principal adverse impacts.

In the context of “considering” principal adverse impacts, the SFDR requires firms to describe mitigating actions taken or planned to be taken, such as by engagement with the company or adherence to international standards, during the reporting period. A firm has some discretion as to how it “considers” principal adverse impacts. In the Commission’s Q&As of April 2023, when discussing the meaning of “consider” in this context, the Commission referred to Recital 18 of the SFDR and stated that firms should disclose on their websites both a description of the PAIs and the procedures put in place to mitigate those PAIs.

Considering principal adverse impacts does not necessarily entail qualifying the investment policy by prohibiting the investment due to the existence of the adverse impact. Where a firm is considering PAIs in such a way as to qualify the fund’s investment policy, then the fund is likely to qualify, at a minimum, as an Article 8 fund.

1. Articles 3 and 5 of SFDR
2. Article 4 of SFDR
3. A “large group” as referred to in Article 3(7) of Directive 2013/34/EU is a group consisting of parent and subsidiary undertakings included in a consolidation which, on a consolidated basis, exceeds at least two of these three criteria: (i) balance sheet total: EUR20m; (ii) net turnover: EUR40m; and (iii) average number of employees during the financial year: 250.
4. According to the Commission’s answers on the interpretation of the SFDR of April 2023, the definition of who constitutes an employee is governed by national law.

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Invest Europe Guide on the EU SFDR and Taxonomy

Member guides

30 May 2023

This new Invest Europe members-only Guide aims to clear up some of the grey areas around the day-to-day application of the EU Sustainable Finance Disclosure Regulation (SFDR), as well as its interplay with the EU Taxonomy. It has been developed by industry experts, for practitioners, outlining current best practices and answering common questions.