EU regulators flag ‘misleading’ SFDR disclosures

Financial institutions should not reference their broader ESG processes when explaining why they do not consider the negative impacts of their investment decisions on environmental and social KPIs, European regulators said last week.

Under the EU’s Sustainable Finance Disclosure Regulation (SFDR), financial institutions are required to describe how they assess “principal adverse impacts” (PAI) on sustainability factors as part of their investment processes, or why they have chosen not to do so.

However, a review of voluntary disclosures made over the past year by the European Supervisory Authorities (ESAs) found that overall compliance “appears to be low”, with financial institutions not providing substantial reasoning for the lack of PAI due diligence, and no indication when they intend to begin doing so.

Describing elements of ESG integration when justifying non-compliance with PAI due diligence requirements is “potentially misleading for investors”, said the ESAs, when these details “could be published in a separate section of the website”.

An ESA spokesperson explained that such disclosures could “risk confusion on whether financial institutions comply with the requirement of considering adverse impacts of investment decisions on sustainability factors”.

According to the ESA’s review, the most common reasons given for non-compliance are lack of data, insufficient resources and “challenging, uncertain and incomplete regulatory requirements”. It also noted that a number of national regulators, who will be responsible for enforcing the SFDR, have “admitted that ensuring compliance… was not amongst their supervisory priorities”.

The disclosures examined by the ESAs were made by financial institutions with less than 500 employees, which are therefore exempt from mandatory SFDR reporting. The ESAs will conduct a separate review of mandatory SFDR disclosures by the end of the year.

Separately, UK financial regulator the Financial Conduct Authority has warned that companies that fail to make sufficiently detailed climate disclosures despite being required to do so may be subject to enforcement action.

Under the UK’s listing requirements, companies on the London Stock Exchange premium market have been required to make climate disclosures aligned to the TCFD recommendations since 2021.

The FCA, in partnership with audit watchdog the Financial Reporting Council, has analysed the disclosures of all the 171 premium listed commercial companies with December 2021 year-ends to assess whether the new rules has resulted in a “material improvement”.

The two bodies found that the most common reporting gaps related to the quantitative elements of TCFD reporting, such as scenario analysis and the adoption of climate-related metrics and targets. In addition, there were some instances of companies misrepresenting the level of detail included within their climate disclosure.