Industry groups split on value of proposed SFDR reforms

Broad welcome for some simplifications, but concerns remain around data for social PAIs and conflict with Level 1 review.

Investment industry associations were divided on the value of proposed additions and changes to SFDR in response to a consultation carried out by European regulators.

In April, Europe’s three financial regulators (the ESAs) proposed a series of changes to the SFDR delegated regulation, including simplification of reporting templates, new mandatory and voluntary social indicators, and a DNSH “safe harbour” to avoid conflicts between differing applications of the principle between SFDR and the EU Taxonomy.

The changes were part of a review to broaden the disclosure framework and address technical issues that have emerged since the legislation was originally agreed.

The Investment Company Institute (ICI) questioned the value of making additional changes given an upcoming review of the entire regulation, warning that proposed changes “could do more harm than good”.

The Principles for Responsible Investment (PRI) said the proposals should improve transparency and comparability, which would help address some usability issues.

In its response, Eurosif welcomed proposals to simplify templates and a set of proposals to make a distinction between targets for the decarbonisation of a portfolio itself or underlying holdings. However, it said a full review of the SFDR Level 1 legislation – which will require new negotiations between the European Parliament and Council – is still necessary to address fundamental issues, and consistency is needed with other regulatory workstreams including on fund labelling and greenwashing.

The ICI was more critical of the proposals, warning that current disclosures are not fit for purpose and require changes to the Level 1 legislation to make them more meaningful for retail investors.

“Expanding disclosure requirements, making cosmetic changes to the disclosure templates, or adding a dashboard at this time will not improve disclosures for the benefit of investors, but these changes would result in significant implementation costs for financial market participants,” it said.

It also called on the ESAs to maintain the status quo on DNSH in order to avoid market disruption, and to more closely align with what the European Commission has previously said on the topic.

The EU’s own industry expert group – the Platform on Sustainable Finance – said it “celebrates” clarifications from the European Commission that taxonomy-aligned investments are considered sustainable investments under SFDR without need for a further DNSH assessment. However, given that these clarifications were published in June, the ESA’s proposed approach “needs to be rethought” in light of this.

The platform said it supported the ESA’s proposal, but that it had several prerequisites in order to work, including completion of the taxonomy, development of general DNSH criteria for economic activities that neither contribute to nor impact environmental objectives, and aligning social and governance Principal Adverse Impact (PAI) indicators with taxonomy minimum safeguards.

Both the ICI and alternatives industry group the Managed Funds Association (MFA) questioned the timing around the consultation.

ICI acknowledged that the ESAs had been mandated to carry out the consultation by the Commission, but warned that “impending fundamental changes” to SFDR and the fact the consultation came before the first set of PAI disclosures “should inform the ESAs’ next steps”. It also warned that they should reconsider introducing new obligations that would exacerbate concerns around regulatory instability.

The MFA, which also raised concerns about the treatment of derivatives under SFDR, said it “respectfully questions” the timing of the effort, and wished “to flag the potential negative unintended consequences of further developing the technical and granular detail of the current framework”, given other efforts currently underway.

Growing PAIns

The consultation document proposed four mandatory social indicators, two of which are entirely new. These relate to portfolio company earnings in countries identified as non-cooperative tax jurisdictions, the share of investments in companies not committed to respect trade union activity, proportion of employees in portfolio companies earning less than the “adequate” wage as defined by EU laws, and fund exposure to tobacco production.

Consultation responses also highlighted concerns about the European Commission dropping a proposal by the EU standards body EFRAG that companies would be required under incoming new sustainability reporting rules to disclose data points that investors need to meet their mandatory PAI reporting.

The first set of these new rules for corporates, the European Sustainability Reporting Standards (ESRS), are also the subject of a consultation, which closes on Friday. Crucially, the European Commission’s draft rules have introduced a materiality assessment for some reporting indicators, which impacts the reporting ability of financial institutions on PAI indicators.

The platform recommends making reporting of PAIs critical to all sectors mandatory in ESRS standards without a materiality assessment, and allowing companies to report a “qualified zero” where they do not conduct relevant economic activities, such as in the case of PAI 9, which deals with hazardous and radioactive waste.

This concern was backed by other respondents.

Elise Attal, the PRI’s head of EU policy, warned that materiality assessments on certain disclosures under ESRS could result in “a potential failure to report the information that investors urgently need to assess the sustainability risks, opportunities, and impacts of their investments and meet their requirements under SFDR”. She recommended policymakers maintain consistency with the final ESRS.

A spokesperson for Morningstar told Responsible Investor that regulators should prioritise implementation challenges over the addition of new indicators, saying that it was still unclear if ESRS would close the data gap for PAIs. Provided this was the case, Morningstar is not opposed to new mandatory social indicators, they said.

However, PAIs are currently a “compliance exercise”, they warned, noting that they are backward looking and exclusively focused on negative impacts and as such of little use to investors who also consider positive impacts and forward-looking elements. Technical and fundamental issues should be addressed to allow reporting on PAIs to become decision useful, they said.

The next step for the ESAs will be to submit a final report to the Commission on the proposed changes, which is expected to be adopted later this year.