New EU Rules for Taxonomy-Related Product Disclosures

On 22 October 2021, the three European Supervisory Authorities (EBA, EIOPA and ESMA – the “ESAs“) delivered to the European Commission the expected Final Report with draft Regulatory Technical Standards (RTS) with respect to additional pre-contractual and periodic disclosure relating to financial products that make sustainable investments contributing to environmental objectives (“Draft SFDR Amendment RTS” – JC 2021 50). By virtue of such new draft rules, the EU will regulate the market by establishing standardized disclosures.

Under a formalistic approach, such new Draft SFDR Amendment RTS as level 2 measures under the EU Sustainable Finance Disclosure Regulation (“SFDR“, Regulation (EU) 2019/2088) aim to

• provide disclosures to end investors regarding the investments of financial products in environmentally sustainable economic activities;
• provide end investors with comparable information to make informed investment choices; and
• establish a single rulebook for sustainability disclosures under the SFDR and the Taxonomy Regulation (Regulation (EU) 2020/852).

Background

Back in February this year, the ESAs published a final report on draft level 2 RTS with regard to the content, methodologies and presentation of disclosures under the SFDR (“Draft SFDR RTS” – JC 2021 03). The new Draft SFDR Amendment RTS now overhaul the developments under the draft SFDR RTS to a large extent: even though a final version of such SFDR RTS has not been published yet, the new Draft SFDR Amendment RTS clearly show several amendments in comparison to the Draft SFDR RTS such as comprehensive amendments in standard pre-contractual and reporting disclosures templates which must be used in the future to disclosure.

The ESAs agreed to amend the existing Draft SFDR RTS and their accompanying templates in order to minimize duplication and complexity, thereby creating a “single rulebook” functioning for both, the original empowerments in the SFDR and the additional ones by the EU Taxonomy Regulation. The new changes reflect responses the ESAs have received from market participants to the Joint Consultation Paper on Taxonomy-related Sustainability Disclosures – Draft RTS with regard to the Content and Presentation Disclosure pursuant to Art. 8 (4), 9 (6) and 11 (5) of the SFDR of 15 March 2021 (JC 2021 22).

Main Changes

The Draft SFDR Amendment RTS contain the following further proposals for products under Art. 5 and 6 of the EU Taxonomy Regulation with strict disclosure requirements (comparable to a key investor document):

• inclusion of pre-contractual and periodic disclosures that identify the environmental objectives to which the product contributes and show how and to what extent the product’s investments are aligned with the EU Taxonomy;
• for measuring how and to what extent activities funded by the product are aligned with the EU taxonomy, the proposals consist of two elements:
  • two graphs showing the taxonomy-alignment of investments of the financial product based on a specified methodology that calculates that alignment; and
  • an indication of whether the compliance of taxonomy-aligned activities with the criteria of Article 3 of the EU Taxonomy Regulation will be subject to an assurance provided by an auditor or a review by a third party.

The Draft SFDR Amendment RTS covering how and to what extent investments underlying the financial product are in economic activities that qualify as environmentally sustainable under the EU Taxonomy Regulation require that the financial product under Art. 5 and 6 of the EU Taxonomy Regulation calculates the extent of taxonomy alignment of investments in two ways: a first one, by calculating the ratio between a weighted average of taxonomy-aligned investments in the numerator divided by all investments in the denominator. Thereby, the financial market participant is required to calculate the taxonomy activity contribution of non-financial investee companies by turnover by default, or by capital expenditure or operational expenditure when justified by the features of the financial product. A second ratio is calculated in the same way as the first except but excludes all sovereign exposures (which includes any investment that results in an exposure to central governments, central banks and supranational issuers) from both the weighted average of taxonomy-aligned investments in the numerator and from all investments in the denominator. These two key performance indicators (KPI) should be graphically presented and accompanied by the breakdown between enabling and transitional activities in accordance with Article 5 of the EU Taxonomy Regulation. In order to disclose “how” investments underlying the financial product are made in economic activities that qualify as environmentally sustainable under the EU Taxonomy Regulation, the rules also propose an indication of whether the compliance of taxonomy-aligned activities will be subject or (for periodic disclosure) has been subject to an assurance provided by an auditor or a review by a third party.

No Derivatives in the Numerator of the KPI

Contrary to suggestions of a derivatives association, the ESAs have decided not to include derivatives in the numerator of the KPI for the time being but this issue may be reconsidered in the future once there may be more evidence in this area. However, the ESAs agreed that netting should be recognized in the numerator, to ensure a fair representation of the economic exposure to securities in the numerator. It remains to be observed how this issue will develop in the near future.

What next?

The European Commission will scrutinise the Draft SFDR Amendment RTS and decide whether to endorse them within 3 months of their publication. It has indicated in a recent letter to the European Parliament and the Council that all the Draft SFDR RTS and Draft SFDR Amendment RTS will be adopted in one instrument (single rulebook) with an expected application date of 1 July 2022. According to ESAs, the date of application, originally indicated as 1 January 2022, is likely to be moved forward.

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