European Commission Q&A on SFDR - Five Key Takeaways for Investment Managers

Sidley comments

This guidance would appear to diverge from current market interpretations that had understood that the good governance requirement applied only to those companies that an FMP has identified as contributing to the environmental or social characteristics of the Article 8 financial product.

The Commission provides equivalent guidance regarding Article 9 financial products. The Commission has previously indicated that all of the investments held by an Article 9 financial product must be sustainable investments, except for investments held in order to meet requirements in accordance with prudential, product-related, sector specific rules (e.g., hedging or liquidity). The Commission also indicated that investments held for hedging and liquidity purposes have to meet minimum environmental or social safeguards, that is, such investments must be in line with the sustainable investment objective of the financial product. Based on the latest guidance, it would appear that if such investments include investments in companies, those companies must follow good governance practices.

This guidance may require FMPs with Article 8 and Article 9 financial products to reassess their current portfolios to confirm that any investments in companies that are not intended to contribute to the promotion of environmental or social characteristics or the attainment of the sustainable investment objective nonetheless meet the good governance requirement.

Sidley comments

The practical effect of the words mutatis mutandis in Article 6 of the Taxonomy Regulation has remained unclear, and the Commission’s guidance does not address this specifically. The view widely held has been that Article 5 of the Taxonomy Regulation only applies if the Article 8 financial product commits to making sustainable investments. Indeed, this interpretation appears to be reflected in the pre-contractual disclosure templates for Article 8 financial products that the Commission recently adopted.

In its current Q&A, the Commission notes that Article 6 of the Taxonomy Regulation applies to financial products falling within Article 8 of the SFDR that promote environmental characteristics and that “it is irrelevant” whether a financial product commits to invest in economic activities that contribute to an environmentally sustainable investment objective; however, this is consistent with the generally held view that it is the prescribed statement set out in Article 6 of the Taxonomy Regulation that applies to environmentally focused Article 8 products.

The Commission’s reasoning does not specifically state that the effect of the words “mutatis mutandis” is to require Article 8 products that do not otherwise make sustainable investments to comply with Article 5 of the Taxonomy Regulation. Nonetheless, this appears to be the effect of the Commission’s guidance, which asserts that such products are required to disclose information “based on an assessment of reliable data with regard to whether investments will be in economic activities that contribute to an environmental objective.”

Sidley comments

As noted above, this guidance appears to diverge from basis on which the pre-contractual disclosure templates for financial products falling within Article 8 are set out. In particular, when addressing the disclosure under Article 6 of the Taxonomy Regulation, the guidance notes to those templates refer to the environmental objectives set out in Article 9 of the Taxonomy Regulation to which the “sustainable investment underlying the financial product contributes” (emphasis added). In other words, the question on Taxonomy alignment is to be completed only where the Article 8 product will “partially invest in sustainable investments.”

As a result of the Commission’s position, FMPs may need to revisit their pre-contractual disclosures made under Article 8 of the SFDR, noting that the obligation to disclose under Article 6 of the Taxonomy Regulation came into effect on 1 January 2022 and is not contingent on the pre-contractual disclosure template set out in the RTS adopted by the Commission coming into force (expected 1 January 2023).

Sidley comments

One common criticism of the SFDR and Taxonomy Regulation framework has been that public companies are not yet required to disclose Taxonomy alignment data, making it difficult for FMPs to disclose the Taxonomy alignment of their portfolios. The Commission appears to rebut this criticism by noting that such information “is not a prerequisite information source” as financial products invest “in a myriad of underlying financial instruments,” including in issuers not subject to Taxonomy alignment disclosures.

As such, the Commission emphasises the responsibility of FMPs to collect their own data from issuers as to how and to what extent the investments underlying the financial product are in economic activities that qualify as environmentally sustainable. That is, FMPs cannot rely on the fact that public disclosures may not yet have been made by EU public companies, as they must be proactive collectors of Taxonomy-alignment data anyway.

Accordingly, where an FMP “fails to collect data,” its pre-contractual and periodic disclosures must indicate zero taxonomy alignment.
The Commission acknowledges recital 21 of the Taxonomy Regulation, which refers to companies and issuers that are not required to publicly disclose taxonomy alignment, and the ability to exceptionally use “complementary assessments and estimates” as to Taxonomy alignment “on the basis of information from other sources” (i.e., other than the company); however, the Commission does not extend the scope of this recital to issuers that are otherwise subject to a public disclosure obligation under the Taxonomy Regulation, and so the recital remains narrow in practice.