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The Sustainable Finance Disclosure Regulation (SFDR) is designed to increase and harmonise financial market participants’ (FMP) transparency and disclosure surrounding their sustainability activities, products and impacts, and to decrease information asymmetries and greenwashing between the FMP ‘principals’ creating and promoting sustainability-oriented investment products and services on the one hand, and the financial market agents or end investors mandating and/or using them on the other.
In addition to the quest to create a harmonised approach to sustainability disclosure in financial markets, the SFDR recognises the need for proportionality with regard to FMP size, nature and scale of activities, and types of financial products made available. This has informed the ‘derogation’ in Article 4 of the Regulation, which outlines how FMPs and financial advisers with less than 500 employees are not subject to the disclosure obligations on the principal adverse sustainability impacts (PAI) at entity level, but are required to ‘explain’ – on a specific section of their websites – why they are not considering the adverse impacts of their investment decisions on sustainability factors.
This has significant implications for occupational pensions schemes, as most pension schemes in Europe have less than 500 employees. Therefore, this derogation means they can take a ‘voluntary’ approach to disclosing how they are integrating ESG issues into their investment activities. This is further influenced by the fact that the majority of pension schemes are not-for-profit financial entities with a social purpose, whose key objective is to ensure their beneficiaries have a secure pension upon retirement. Hence, pension schemes need to be cautious of any regulatory requirements that could place significant administrative and financial burdens on their ability to pay member and beneficiary pensions when they fall due.
The focus on employee size as opposed to the level of assets under management seems somewhat negligent from a EU sustainability governance and accountability perspective
Notwithstanding these exemptions, the SFDR raises several questions over the role of occupational pension schemes in mandated sustainability governance and accountability in Europe. This is especially noteworthy given the fact that the Institutions for Occupational Retirement Provision Directive (IORP II) – which the SFDR is intended to supplement in terms of ESG integration and disclosure – and the Shareholder Rights Directive also allow asset owners and managers to consider and integrate ESG issues into their activities on a ‘comply or explain’ basis. Hence, ESG risk management and disclosure by occupational pension schemes is rendered voluntary in a European regulatory context overall (unless they are mandated to do so at national level, like they are in France, for example). What’s more, there is no prescribed format under any of these rules for how a pension scheme should properly explain why they are not integrating ESG issues and considering the adverse sustainability impacts of their activities.
This is concerning as, while it is noted that most pension schemes are not considered direct investors (because they invest largely through asset managers and pooled funds), they still hold some of the largest assets under management in Europe, which, when invested, can either pose or mitigate adverse sustainability impacts. They can also influence investment terms through their ESG policies and mandates for their investment managers. But if they are not legally obliged, what incentive do they have (especially the more ‘ESG-cynical’ pension trustee) to meet their social responsibilities and, more importantly, what are the mechanisms that can truly hold them accountable for this?
The focus on employee size in Article 4 of the SFDR as the determinant for mandatory compliance – as opposed to, for example, the level of assets under management and therefore potential adverse sustainability impacts as a result of investments – seems somewhat negligent from a EU sustainability governance and accountability perspective.
IORP II requires pension schemes to recognise their duty of care to members and beneficiaries, to inform them of their ESG due diligence policies and activities, and to seek their ESG preferences; and the SFDR seeks to bolster such disclosure and engagement – the draft SFDR Regulatory Technical Standards (RTS) state that short, ‘customer-facing’ disclosures should be made by occupational pension schemes, for example. But all of this is hampered by the proposed structure of such reporting, with some pension commentators stating that the SFDR RTS indicators will lead to overly complicated reporting. If this is the case, it will mean that the SFDR does not adequately enhance the transparency, disclosure and engagement needs stipulated in IORPs II.
All of this is further complicated when pension schemes are considered ‘FMPs’ under the SFDR (it defines ‘pension schemes’ and ‘pension products’ as financial products) when they are, in the majority of cases, end-investors. This is important because it currently overlooks the potential for pension schemes to play a role in better mandating, monitoring and reporting on how investment managers are exercising their ESG/fiduciary duties to beneficiaries on their behalf, as facilitated by their SFDR asset manager sustainability disclosures. Subsequently, this could extend pension schemes’ role as financial market ‘principals’ further, for the benefit of the SFDR. Hence, better recognition of the ‘dual-role’ of pension schemes as both FMP and end-investors in the SFDR and its RTS is needed.
There remains a number of anomalies when it comes to the applicability of the SFDR to the pensions sector, and along with the simultaneous ‘comply and explain’ nature of IORP II, this raises concerns about the role of the pension sector in sustainability governance and accountability in European financial markets in general.
All of this has a ‘knock-on’ effect for the chain of governance and accountability for ESG in the pensions sector more broadly. Take Ireland, where pension sector reforms are needed more generally, levels of ESG literacy are relatively low, IORP II is yet to be transposed, and the Irish Pensions Regulator has stated it will not be issuing guidance on the SFDR before 2022 and will not develop a specific template for pension scheme ‘explanations’ under SFDR. While this ‘wait-and-see’ attitude on the part of the regulator may be prudent now, due to ongoing uncertainty about the forthcoming structure and enforcement of SFDR at technical level, the lack of guidance for those pension schemes trustees who are just starting out on their ESG journey in Ireland is not helpful.
Considering all of the above, it would appear that this may be the perfect time to reconsider the feasibility and importance of making the ESG requirements in IORP II mandatory, as opposed to ‘comply or explain’, in the 2023 revision of the Directive, if it is not practical to do so for pension schemes in the SFDR at present. Otherwise, serious questions will remain around pension schemes’ abilities to fully meet their social responsibilities and how they can be held to account for this.
Niamh O'Sullivan is an Assistant Professor in Sustainable Business at the International Centre for Corporate Social Responsibility, Nottingham University Business School
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