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SFDR PAI Reporting: ESAs Publish Good and Poor Practices

In the second annual report on principal adverse impact (PAI) disclosures, the ESAs detail good and poor practices for both product (Article 7) and entity-level (Article 4) reporting.

Good and poor practices

At the end of September, the ESAs published their findings from an April/May 2023 review of PAI disclosures.  A summary of the ESAs’ findings, including good and poor practices identified, is set out below.

  • PAI due diligence policy disclosures: policy disclosures remain extremely limited. The ESAs’ cited as poor practice the disclosure of participation in sustainability-related international organisations and initiatives (e.g. Net-Zero Asset Owner Alliance, Climate Action 100+, Principles for Responsible Investments).
    • Good practice: DD policy disclosures detailing the strategies adopted for identifying and weighting key PAIs and the organisational policies and procedures assigning responsibility for implementation of those strategies.
  • Explanation of PAI non-compliance: non-compliance explanations that rely on the market participant having fewer than 500 employees misinterpret the spirit of Article 4(1)(b). Some non-compliance explanations fail to include an indication of when PAIs will be considered in the future, as required under SFDR.
    • Poor practice: explanations that reference unclear procedures and lack of legal clarity in the SFDR PAI consideration rules.
  • Product-level PAIs: market participants’ display a limited understanding of such disclosures with some confusing SFDR Article 7 with Taxonomy Article 7.
    • Good practice: reserving publication of further information on PAI consideration for the first PAI entity statement (fell due on 30 June 2023).
  • Paris alignment: voluntary disclosures of alignment with the Paris objectives remain vague and fail to reference indicators used to measure the decarbonisation path of their investments.
    • Good practice statements including identification and prioritisation of PAIs, actions taken to mitigate such impacts, description of engagement policy, list of international standards respected, and degree of alignment with the Paris Agreement.
  • Accessibility of PAI reports: in line with SFDR accessibility rules, disclosures should not be hidden under ‘required information’ or in the ‘download’ section of websites.
    • Poor practice: non-compliance by market participants because they do not have a website.
  • Different information for professional and retail investors: disclosures must be the same for professional and retail investors, and must be made easy and straightforward to find, irrespective of the type of investor.
  • Consideration of PAIs at group level but not on solo basis: sub-threshold entities that opt to explain non-compliance with SFDR PAI consideration requirements while reporting on group-level PAIs is cited as poor practice by the ESAs.

ESA Recommendations

To the Commission:

  • consider replacing the 500-employee threshold for mandatory PAI statements with e.g., a threshold based on the size of the market participants’ investments;
  • consider making product-level PAI disclosure rules comply or explain regardless of whether entity-level PAIs are considered.

To NCAs:  

  • follow up on non-compliance and consider use of enforcement tools;
  • support market participants with publication of supervisory expectations;
  • build up NCA expertise.

ESA Clarifications

  • ‘Consider’ and ‘take into account’: the requirement to ‘consider’ PAI means that disclosures should detail how adverse impacts of investments are addressed, e.g., how these are reduced/mitigated. In contrast, the requirement to ‘take into account’ the PAI for DNSH of sustainable investments is a requirement to take into account the PAI indicators to ensure these do not cause significant harm to the environment or society.
  • ‘ESG criteria’, ‘ESG risk’ and ‘sustainable investment goals’: such terms are not related to PAI consideration which should instead focus on ‘sustainability impacts’, ‘sustainability indicators’, the ‘engagement policies to address the adverse impacts of the investment decisions’, and the ‘degree of alignment with the objectives of the Paris Agreement’ as a good measure of adverse climate impacts.

Next steps

The above findings have issued to the Commission and are likely to inform both future supervisory actions and the preparation of SFDR Level 1 and Level 2 revisions.  As such, they should be factored in to fund managers’ compliance processes and procedures for any product and/or entity-level PAI reporting.  Given the review timeframe, June 2023 entity-level PAI statements were not reviewed for the purposes of the ESAs’ report but will be for future iterations of the report.