Sustainable Finance Update – Recent Investment Funds Related Developments – Finance and Banking

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Despite disruption to work programmes wrought by the COVID-19
pandemic, the EU institutions are pressing ahead with sustainable
finance initiatives as a priority and there has been a number of
significant developments in the past quarter. These include the
adoption by the Council of the EU (“Council”) and the
European Parliament of the Taxonomy Regulation, the European
Supervisory Authorities’ (“ESAs”) consultation on
regulatory technical standards (“RTS”) under the
Sustainable Finance Disclosures Regulation (“SFDR”) and
the publication by the European Commission (“Commission”)
of Level 2 measures under the UCITS Directive and the AIFMD
addressing the integration of sustainability factors.

Adoption of the Taxonomy Regulation

In late 2019, following lengthy debate, the EU institutions
agreed on a proposal to create a taxonomy or classification system
to provide market clarity on what economic activities should be
considered “sustainable” and to prevent
“greenwashing” – the
Taxonomy Regulation
. One of the contentious issues in the
negotiations related to the classification of gas and nuclear
investments. In the final text, these investments may be classified
as “transition” or “enabling activities” that
assist in moving towards a greener economy. The Council and the
European Parliament have now both voted to formally adopt the
Taxonomy Regulation, paving the way for its publication in the
Official Journal of the EU on 22 June 2020. The Taxonomy Regulation
will apply, with respect to activities that substantially
contribute to climate change mitigation and adaptation, from 1
January 2022. The regulation will apply with respect to activities
that substantially contribute to the four other environmental
objectives set out in the legislation from 1 January 2023.

ESAs Consultation on RTS under the SFDR

On 23 April 2020, the ESAs published a
setting out draft regulatory technical standards
(“RTS”) with regard to the content, methodologies and
presentation of sustainability-related disclosures under the

The SFDR came into force at the end of December 2019 and will
apply from March 2021. It seeks to harmonise the ESG disclosure
requirements for financial market participants, including UCITS
management companies and AIFMs. The SFDR requires the integration
of ESG risks by all financial products within its scope and also
contains additional requirements for two types of financial
product: (1) products promoting environmental or social
characteristics or a combination of these characteristics; and (2)
products which have sustainable investment as their objective.

Challenges posed by Inconsistencies between SFDR and
Taxonomy Regulation

The SFDR is closely linked with the Taxonomy Regulation
discussed above, which, in addition to setting out an EU
classification system for sustainable activities, also prescribes
disclosures to be made by financial market participants. However,
the SFDR and Taxonomy Regulation were not agreed and adopted at the
same time, with the adoption of the Taxonomy Regulation being
delayed due to political debate as to what should be categorised as
sustainable activities, as noted above.

In its consultation paper, the ESAs identify the challenge
arising from the fact that the negotiations on the draft Taxonomy
Regulation were ongoing when the SFDR entered into force. The
finalised SFDR defined “sustainable investments” without
reference to the Taxonomy Regulation. The ESAs discussed whether
the environmentally sustainable products under article 9 of the
SFDR are limited to those investing in activities contributing to
the environmental objectives according to the proposed Taxonomy
Regulation. While such an approach would be favourable in terms of
comparability of sustainable investments and combatting
“greenwashing”, the SFDR does not link environmentally
sustainable investments to the draft Taxonomy Regulation. The ESAs
hope to iron out any inconsistencies between the two regulations
when they are preparing RTS under the Taxonomy Regulation. The ESAs
also highlight the relationship between the concept of
“principal adverse impact” in the SFDR and the concept of
“no significant harm” in the Taxonomy Regulation and
invite the Commission to consider the feasibility of clarifying the
relationship between the two concepts in the future.

Principal Adverse Impact Disclosure

The SFDR introduces the idea of “principal adverse impact
of investment decisions on sustainability factors” and
requires disclosure on a firm’s website where a firm has
decided to take adverse impacts into account. Principal adverse
impacts are described in the recitals to the SFDR as impacts of
investment decisions and advice that result in negative effects on
sustainability factors (ie, environmental, social and employee
matters, respect for human rights, anti‐corruption and
anti‐bribery matters). The RTS elaborate on the content and
presentation of information required in relation to the principal
adverse impact disclosure, including the use of a mandatory
reporting template.

Pre-contractual, Periodic and Website

The RTS set out details on the content and presentation of
information to be disclosed in the pre-contractual, website and
periodic report disclosures required under the SFDR.

The ESAs propose that mandatory disclosure templates for
pre-contractual and periodic product disclosure should be developed
to harmonise how the information is provided. The drafting of these
templates has been delayed pending greater certainty regarding what
should be disclosed. The ESAs envisage launching a separate process
to develop these templates after the consultation paper has been

Next Steps

The closing date for comments on the draft RTS is 1 September
2020. Following the close of the consultation, the draft RTS will
be finalised and submitted to the Commission. The RTS will
generally apply from 10 March 2021, although certain provisions
relating to those products with an ESG focus or objective will
apply from 1 January 2022.

Integration of Sustainability Factors in the UCITS Directive
and the AIFMD

In addition to the Taxonomy Regulation and the SFDR, a further
element of the Commission’s Action Plan on Sustainable Growth
published in 2018 was the amendment of the level 2 measures under
various pieces of legislation forming the EU financial services
regulatory framework, including amendments to both the UCITS
Directive and the AIFMD to explicitly require management companies
to integrate sustainability risks in the investment decision-making
process. Referring to the fact that the existing legislative
frameworks do not explicitly mention sustainability risks, the
Commission notes, “it is necessary to clarify that processes,
systems and internal controls of management companies reflect
sustainability risks, and that technical capacity and knowledge is
necessary to analyse those risks.”

The draft delegated acts were published on 8 June 2020 and the
Commission has requested feedback by 6 July 2020. The obligations
would apply 12 months after the date on which the legislation is
published in the Official Journal of the EU.

The key elements of the proposed amendments are set out

  • Definitions of “sustainability
    preferences”, “sustainability risks” and
    “sustainability factors” are introduced into the level 2
    measures, as well as the concept of “material adverse
    impact” on the value of investments.

  • Management companies must assess all
    relevant sustainability risks when conducting due diligence on

  • Management companies must identify
    conflicts of interest which arise as a result of the integration of
    sustainability risks in processes, systems and controls.

  • Assessment and management of exposure
    to sustainability risk must be incorporated into the risk
    management policy and procedures of the management company.

  • Sustainability risks must be taken
    into account in the organisational structure of the management

  • Management companies must retain the
    necessary resources and expertise required for the integration of
    sustainability risks.

  • Larger management companies, (ie,
    those with an average of more than 500 employees) and those who
    choose voluntarily to comply with the principal adverse impact
    reporting obligation under the SFDR, must take into account
    principal adverse impact of investments on sustainability

Alongside the proposed amendments to the level 2 measures under
the UCITS Directive and the AIFMD, the Commission also published
proposals integrating sustainability factors relating to MiFID II,
the Solvency II Directive and the Insurance Distribution

Further Developments

Further evidence that the Commission is determinedly pushing
ahead with its sustainable finance initiatives is the publication
of its
on its Renewed Sustainable Finance Strategy, which
is open for feedback until 16 July 2020.

On 9 June 2020, a
joint letter
was published by European Fund and Asset
Management Association (“EFAMA”) in relation to the
establishment of a centralised register for ESG data. The letter
emphasises that the recent regulatory developments in the context
of the EU sustainable finance agenda create an urgent need for
publicly available ESG data as well as a need to identify how to
enhance their sourcing.

For an overview of the SFDR, Taxonomy Regulation and the Low
Carbon Benchmarks Regulation, please see our
Sustainable Finance and Investment Funds
briefing note.

Originally published 14 July, 2020

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