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New Taxonomy/SFDR FAQ

Last month saw the publication of yet another extensive and highly impactful EU package of sustainable finance measures.

The package includes a Commission FAQ clarifying the tests for Taxonomy-aligned investments and SFDR sustainable investments.

Taxonomy clarifications

For an investment in an economic activity to qualify as Taxonomy aligned, the activity must satisfy the four criteria of (i) contributing substantially to one or more of the Taxonomy’s environmental objectives (ii) not significantly harming any of those objectives, (iii) complying with minimum safeguards and (iv) complying with the relevant Taxonomy technical screening criteria.

The FAQ clarifies that the minimum safeguards at (iii) above are met when investee companies implement due diligence and remedy procedures to ensure their activities align with the OECD guidelines for Multinational Enterprises (MNE Guidelines), the UN Guiding Principles on Human Rights (UNGP) and do not significantly harm (DNSH) minimum social standards.

However, an investment in company which fails to achieve alignment with the MNE Guidelines and UNGP will not necessarily result in the investment failing the minimum safeguard test.  As set out in the FAQ, an investee company can satisfy the minimum safeguard requirement provided it has implemented the appropriate due diligence and remediation procedures and discloses actual and potential adverse impacts along with an explanation of what it did to identify, prevent, mitigate or remediate them and why it could not eliminate the impacts.

To satisfy the above-mentioned DNSH test, activities should be assessed, at a minimum, against the mandatory SFDR principal adverse impact (PAI) indicators for social and employee matters, respect for human rights, anti-corruption and anti-bribery matters set out at Annex I to the SFDR Delegated Regulation (Level 2).

SFDR clarifications

The FAQ clarifies that investments in Taxonomy-aligned activities automatically qualify as sustainable investments.  This is because each limb of the SFDR sustainable investment test is met by activities which comply with the requirements of the Taxonomy.

However, where an investee company carries on more than one activity and only one or more, but not all of those activities are aligned with the Taxonomy, the whole company can only qualify as a SFDR sustainable investment if the remainder non-Taxonomy aligned activities satisfy the SFDR test for sustainable investments i.e., only an investment in the Taxonomy-aligned activities of an investee company automatically qualify as SFDR sustainable investments, not the whole/all of the activities of the investee company.

If the sustainable investment in question is specifically for Taxonomy-aligned activities e.g., a bond which specifies the use of proceeds for Taxonomy-aligned activities, then the whole investment can automatically qualify as a SFDR sustainable investment.  However, if it is a general debt or equity investment then the non-Taxonomy aligned activities must be assessed against the SFDR test of (i) contribution to the environmental objective(s) and (ii) DNSH compliance using the environmental PAI indicators, before the whole equity or debt investment can qualify as a SFDR sustainable investment.

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If you have any queries on the issues discussed in this article, please get in touch with the key contacts, any member of the Asset Management & Investment Funds team or your usual William Fry contact.