ESAs tell national regulators to consider ‘enforcement tools’ for SFDR non-compliance

EU financial watchdogs see overall improvements in disclosure and supervisory monitoring on PAI indicators but notes ‘incorrect references’ being used by national supervisors in survey responses.

EU flags in front of European Commission building in Brussels

Europe’s financial watchdogs – known collectively as the European Supervisory Authorities (ESAs) – have told national regulators to consider the use of “enforcement tools” for non-compliance with the bloc’s anti-greenwashing rules, as set out by the Sustainable Finance Disclosure Regulation (SFDR).  

In their second annual report on the voluntary disclosure of principal adverse impacts (PAI), the regulatory trinity recommended that national competent authorities (NCAs), “Follow up with non-compliant market participants and consider whether the use of enforcement tools could be appropriate.” 

The ESAs are made up of the European Securities and Markets Authority (ESMA), European Banking Authority (EBA) and European Insurance and Occupational Pensions Authority (EIOPA).

This year was the first that firms falling under SFDR had to disclose the impact of their investment decisions on a series of sustainability factors. 

Investors were required to produce an entity-level report quantifying their impact on 14 mandatory indicators across environmental and social topics, as well as two additional indicators chosen from a separate list. They may also choose to report against more from this list, but it is not obligatory. 

Responsible Investor recently ran a series on PAI indicators.  

The ESAs’ latest report, published Thursday, provides details on a survey of NCAs, designed to gauge the “current state of entity-level and product-level voluntary principal adverse impact (PAI) disclosures under the SFDR”. 

Overall, it revealed an improvement on last year, although they added: “there is still significant variation in the extent of compliance with the requirements and in the quality of the disclosures both across financial market participants and jurisdictions.”  

However, the ESAs also noted instances where the responses it received from NCAs made “incorrect references to specific disclosure obligations, commenting “that there is still an improvement and build-up of expertise needed by the NCAs to enable thorough checking of the compliance.

Disclosure of due diligence policies, which are published along with the PAI impacts, “remains extremely limited”, it was found. “Usually, FMPs [financial market participants] mention the fact that they and/or their parent group participate in sustainability related international organisations and initiatives,” the ESAs wrote. 

‘Vague’ disclosures

Another highlighted area was “vague” disclosures by financial institutions when it comes to alignment with the objectives of the Paris Agreement.  

In the appendix, the ESAs give the example from one NCA of an investment firm that “discloses information under Article 4(1)(a) mentioning the Paris Agreement very generally and in connection with exclusion policies for the coal industry, without a specific level of alignment”. 

Another area that requires improvement according to the ESAs was on instances of non-compliance with PAIs, “where explanations are still not fully complete and satisfactory”. 

“While FMPs mention issues related to data availability and comparability or insufficient clarity from a legal perspective, those explanations remain short and vague,” the ESAs wrote.  

The ESAs, however, welcomed that their questionnaire had “increased the level of NCAs’ awareness of FMPs’ disclosures under Article 4(1)(a) and (b) SFDR” and that the level of monitoring and market observation had “significantly improved”. 

Last year’s report, by contrast, revealed that some NCAs regarded compliance with SFDR and PAI indicators as “not amongst their supervisory priorities”. 

The updated ESAs report also included recommendations for the European Commission, including that the EU’s executive arm set a proportional threshold for reporting on PAI indicators based on investment sizes. The current approach, which is set on the firm having at least 500 employees, “may not be a meaningful way to measure the extent to which investments may have principal adverse impacts on sustainability factors”. 

Another issue raised was that under the current set-up, a financial institution might consider PAI impacts at the entity level but this does not necessitate that they will also do so at the product level, as “investors might expect”.