The EU
The Sustainable Finance Disclosure Regulation (SFDR)1
The SFDR requires financial market participants (FMPs) and financial advisers (FAs) to provide clients and investors with certain ESG-related information in relation to the provision of their services and the marketing of certain financial products, using the mandatory disclosure templates (where applicable). For more detailed information regarding the core disclosure requirements under the SFDR, please see our June 2020 alert.
The SFDR will require FMPs and FAs to make significant changes to their pre-contractual client documentation (e.g., prospectuses), contractual documentation, terms of business, periodic reports (e.g., investor reports), website disclosures and internal policies and procedures to ensure that the relevant ESG data and information is captured and properly disclosed. Firms must be compliant with the majority of the SFDR from 10 March 2021, with periodic reporting requirements applying from 1 January 2022.
The SFDR will be supplemented by Level 2 technical standards (the Technical Standards), which will provide additional detail regarding the content and presentation of the required disclosed information, including the mandatory disclosure templates for pre-contractual and periodic product disclosures. The Technical Standards were due to be published on 31 December 2020, and consequently take effect from 10 March 2021. However, the final drafts were not published by the European Supervisory Authorities until 4 February 2021. In accordance with the European Commission’s (EC) recent letter, whilst compliance with the Technical Standards has been delayed, FMPs and FAs are still expected to comply with the substantive provisions in the SFDR from 10 March 2021, for example, the requirement to ensure a sustainability risk-related policy is in place, and to publish information on the integration of sustainability risks in the investment decision-making process on firms’ websites and in their pre-contractual documents. The EC confirmed many firms which currently comply with non-financial reporting requirements under the EU Accounting Directive 2013/34/EU, or which adhere to international standards, should consider using that information to aid their compliance with the SFDR, in the absence of the finalised Technical Standards. The Technical Standards should be endorsed by the EC within three months of their publication (i.e., by 4 May 2021), and FMPs and FAs will be expected to comply with the Technical Standards from 1 January 2022.
The Taxonomy Regulation
As noted in our June 2020 alert, the Taxonomy Regulation2 introduces a framework for an EU-wide classification system for ESG-related investments to help investors identify the extent to which an economic activity is “sustainable”, with an initial focus on six environmental objectives (being climate change mitigation; climate change adaptation; sustainable use and protection of water and marine resources; transition to a circular economy; pollution prevention and control; and protection and restoration of biodiversity and ecosystems). The Taxonomy Regulation amends the SFDR by imposing taxonomy-specific disclosure requirements on FMPs and FAs.
In November 2020, the EC published draft technical screening standards (TSS) which (when adopted) will clarify the extent to which an economic activity will qualify as “sustainable” because it (a) makes a substantial contribution to a given environmental objective; and (b) does not significantly harm the objectives of climate change mitigation and adaptation.
The EC is expected to adopt the final text of the TSS in early 2021, meaning that regulatory disclosure requirements relating to the objectives of climate change mitigation and adaptation will apply from 1 January 2022. According to the EC, the first company reports and investor disclosures using the EU taxonomy are due from 2022 onwards.
The EC is due to publish and adopt technical standards in relation to the other four environmental objectives in late 2021. As a result, regulatory requirements relating to these objectives will apply from 1 January 2023.
The UK
The impact of EU regulations post Brexit
The UK government has not implemented the Taxonomy Regulation or the SFDR in the UK, but will instead establish its own green taxonomy and environmental disclosure regime.
That said, UK firms may still be subject to the requirements in the SFDR and Taxonomy Regulation to the extent that they market certain financial products in the EU (e.g., a UK fund manager may be required to comply with the SFDR if it markets fund products in the EU under the national private placement regime) and UK portfolio managers acting under a delegation agreement with an EU fund manager may be contractually required to comply with certain requirements in the SFDR and the Taxonomy Regulation to facilitate the EU fund managers’ and/or funds’ compliance with the disclosure or internal procedures requirements imposed on them by the EU regulations.
UK regulations
On 9 November 2020, the chancellor of the exchequer announced various proposals for the financial services sector in the UK, to support the green economy. The key announcements included:
- The UK will make climate-related financial disclosures mandatory across the economy (including occupational pension schemes, insurers, banks and building societies, companies and asset managers) by 2025 by adopting the recommendations of the UK’s joint regulator and government Task Force for Climate-related Financial Disclosures (TCFD). The TCFD published an interim report which set out a roadmap towards compliance with mandatory financial disclosures, with large UK asset managers being subject to disclosure requirements as of 2022 and other asset managers following suit in 2023. Whilst the interim report did not detail the substance of the disclosures that will need to be made, it is anticipated that these will be aligned to the TCFD’s principles-based disclosure recommendations, which focus on governance, strategy, risk management, and metrics and targets. The report also indicates that UK authorities may consider implementing more detailed and specific disclosure requirements in due course.
- The UK will implement its own green taxonomy, using the EU Taxonomy Regulation as its foundation. A UK Green Technical Advisory Group has been set up. This will be responsible for analysing the scientific metrics incorporated within the EU Taxonomy Regulation’s TSS and assessing whether they are appropriate for the UK market. This ultimately leaves scope for UK divergence from the EU Taxonomy Regulation.
- The government will issue its first Sovereign Green Bond in 2021, subject to market conditions.
Emerging industry standards
In response to growing demands from stakeholders and market participants, industry bodies, such as the International Financial Reporting Standards Foundation, have recently launched a consultation on the development of a global set of sustainability reporting standards for companies. In addition, the CFA Institute is seeking to create a set of international disclosure standards for investment products with ESG-related features.
In light of the increasing focus on ESG disclosures, and the growing recognition that managing ESG risks can create long term value for an enterprise, there will be pressure on companies, asset managers and other relevant market participants who are not yet making ESG disclosures to start doing so, even if it is not yet mandatory. For example, the Association of Investment Companies recently announced that it will be publishing individual investment company ESG disclosures on its website from the second quarter of 2021 onwards, giving member investment companies the opportunity to share their ESG policies in an accessible way.
Next steps
In preparation for the introduction of these new measures, firms should take the following actions:
- assess whether they are in scope of the new disclosure requirements;
- carry out an assessment of the impact of the SFDR at the firm and product level, including whether any products promote sustainability;
- if they fall within the scope of the SFDR, ensure that they are in compliance by updating their pre-contractual and contractual documentation and websites, if necessary, by 10 March 2021; and
- consider whether they want to start preparing to make ESG-related disclosures, even if they are not within the scope of the SFDR, in light of growing client and stakeholder demand and pressure.
- Regulation (EU) 2019/2088 on sustainability‐related disclosures in the financial services sector.
- Regulation (EU) 2020/852 on the establishment of a framework to facilitate sustainable investment.
Client Alert 2021-047
