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SFDR

Taxonomy

SFDRMandatory Indicators & Principal Adverse Impact

If you are scratching your head about the new requirements of the Sustainable Finance Disclosure Regulation (SFDR), especially regarding Principal Adverse Impacts (PAIs), you have come to the right place! The directive aims to steer the flow of capital towards sustainable investments , which will reduce the negative impact of fossil fuels and carbon emissions.

Henri Vanhomwegen

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As part of the European Action Plan on Sustainable Finance, financial market participant (FMPs) offering financial products in the EU are required to comply with the Sustainable Finance Disclosure Regulation (SFDR), which is being introduced in stages, starting from March 10th 2021. The purpose is to increase market transparency and direct capital towards more sustainable businesses. For further detail on the main components of the SFDR and its main challenges, see our previous article “SFDR Fundamentals, Challenges and Keys to Success “.

Principal adverse impact statement 

A new final report on draft regulatory technical standards was published by the European Supervisory Authorities (ESAs) on October 22nd 2021 (the RTS). Article 4 of the SFDR requires FMPs to ensure transparency in terms of the consideration of principal adverse impacts of investment decisions on sustainability factors.

The most challenging aspect of the SFDR is probably the new principal adverse impacts (or PAI) regime. Principle Adverse Impact indicators are essentially a set of mandatory indicators and metrics which aim to show financial market participants how certain investments pose sustainability risks. Under these new rules, fund managers, financial advisors and other financial institutions will need to collect ESG data and disclose any sustainability risks associated with their investments and financial products.

The reporting requirements cover the entity and product level, while the entities consist of a firm's policies and decision-making on sustainability risks. The financial products themselves include (non-exhaustive): investment and mutual funds, UCITS, insurance-based investment products, private and occupational pensions and insurance and investment advice.

The principal adverse impact indicators require FMPs to provide extensive disclosures on various ESG-related matters including environmental and social indicators including human rights. They are subject to two types of disclosures, as outlined below: 

  • Entity level disclosures (Under Article 4 of the SFDR) 

These disclosures are based on a “comply or explain” principle urging FMPs to indicate whether they consider the principal adverse impacts on sustainability factors of their investments, and include a statement on their due diligence policies with respect to such impacts. FMPs which do not consider PAIs must explain the reasons being their decision and, where relevant, whether they will consider them in the future.

After a first delay regarding the date of application of the RTS from January 1st to July 1st 2022, the European Commission announced on November 25th 2021 that it would once again push back the RTS’ date of application to January 1st 2023. This was due to the length and technical detail of the regulatory technical standards involved, and the timing of the submissions to the Commission.

However, the first entity level PAI reports were still due in June 2023, based on the reference period of January 1st 2022 to December 31st 2022. Hence, (and starting in June 2023) by 30 June each year financial market participants shall publish the information referred to in paragraphs 1(a), 2, 3 and 4 of Article 4 of the SFDR on their websites (Articles 2 and 4 of the RTS) in a separate section titled 'Principal adverse sustainability impacts statement' Furthermore, this information should be presented in accordance with the template in Annex I of the RTS.

  • Product level disclosures (Article 7 SFDR)

From December 30th 2022, FMPs which consider PAIs on sustainability factors will be required to disclose how each of their financial products considers such impacts in their pre-contractual disclosure documents. FMPs which do not consider principal adverse impact will be required to explain the reasons for that decision in their pre-contractual disclosure documents, effective from 10 March 2021.

Product level disclosures must be included in a firm’s relevant pre-contractual disclosures and periodic reports. The reporting requirements aim to increase transparency on ESG data and therefore to protect the end investor. The presence of the SFDR means that funds cannot simply be described as sustainable investments; firms will have to demonstrate that sustainability and firms will need to explain specifically how they are achieving their ESG goals.

The RTS provides a prescribed format or template for the PAI in Annex I, published on 4 February 2021. It will require FMPs that consider PAI on sustainability factors to provide extensive disclosures on various ESG related matters, including environmental and social indicators. In total, 14 key indicators (9 indicators related to the environment, and 5 covering social factors) are considered mandatory for the proper assessment of adverse sustainability impacts across a range of ESG factors.

In addition to the 14 key indicators set out above, at least one additional environmental indicator and one additional social indicator have to be considered. The PAI statement is intended to show investors and prospective investors how investment decisions made by a financial market participant are (or are not) impacting a prescribed set of mandatory sustainability indicators, and several voluntary ones. The RTS also contains additional indicators deemed as mandatory for reporting on investments in sovereigns and supranationals, as well as  investments in real estate assets.

Requiring all relevant financial market participants to report against the same indicators and to use a standardised template form will encourage investors to compare asset managers’ approaches to sustainable investment, and support them in making truly informed investment decisions. 

Greenomy PAI solution

Greenomy delivers a complete end-to-end reporting solution and allows asset managers to truly understand the ramifications of the SFDR and easily report their answers. Our SFDR Principal Adverse Impact Solution enables financial market participants to measure the performance of their investments against the mandatory PAI indicators and the EU Taxonomy, in order to comply with the new disclosure obligations. It allows companies to collect, aggregate and report all needed data from the relevant parties in order to comply with the SFDR and get ready to report on time. 

Greenomy's platform collects the data directly from issuers through structured questionnaires, it automatically imports and computes the mandatory and voluntary PAIs at the financial product and entity level, and delivers the information to stakeholders through a dynamic dashboard, helping them to easily review the data pertaining to their SFDR compliance. This platform allows investors to report the PAI Impacts of funds and provide coverage of all mandatory and additional PAIs applicable to companies, as well as report on their EU Taxonomy alignment.

In addition, Greenomy's platform offers: 

  • Easy to understand definitions of all metrics, explaining exactly what information is gathered
  • Access to direct company data, helping to track the performance of your entire portfolio over time.
  • Respecting metrics defined by the SFDR regulation
  • Computation of mandatory and additional PAI metrics
  • Computation of EU Taxonomy alignment at the product level
  • Presentation of data included in a tabular format, which ensures that the relevant numbers to be easily visible
  • Output charts and other graphics that can be easily interpreted by users, and used for website, pre-contractual and periodic disclosure

With the support of Greenomy's PAI solution on board, complying with the SFDR and reporting on the Principal Adverse Imdpacts of funds is more straightforward, and easier to understand too.

We at Greenomy are developing award-winning digital solutions to help you tackle the EU Taxonomy/SFDR/NFRD/CSRD challenge: try it yourself, book a demo now on our homepage!

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