Sustainable Finance Disclosures Regulation and the impact of the delayed regulatory technical standards on UK firms.

December 4, 2020 by Clare Curtis

The European Commission has confirmed in a letter to Trade Associations that the regulatory technical standards (Level 2 RTS) which underpin the European Union’s (“EU”) Sustainable Finance Disclosures Regulation (“SFDR”) will be delayed.  It is likely that the new implementation date will now be January 2022. Firms however, should not be overly complacent as those who were impacted before this announcement will still need to comply with the Level 1 SFDR in full with effect from the original compliance date of 10 March 2021.  Firms will therefore need to continue to work towards implementing these requirements in line with the original deadline if they wish to market their products in to the EU.

So which UK firms need to comply with the Level 1 requirements and what technical standards will be outstanding under the delayed Level 2 RTS? Any relevant firms (such as banks, insurance companies, pension funds, investment firms and fund managers (looking to market in to the EU will need to comply with the Level 1 requirements whereas those who are UK based and UK focused will need to continue to comply with the Task Force on Climate-Related Financial Disclosures (“TCFD”) regime).  Firms who are impacted will need to comply with the Level 1 requirements are as set out in the SFDR on a best-effort basis without having the Level 2 RTS requirements.


Given the delayed Level 2 RTS it is important to understand the fundamental principles that underpin the need for the SFDR in the first place so that firms can implement these without having the detail that was expected prior to March 2021. The SFDR was born out of a package of EU reforms on sustainable finance and the need to create an ESG regulatory framework.  The concern was that some firms were marketing products as having an Environmental Social Governance (“ESG”) foundation but were not properly taking this into consideration as part of the investment process.  As such, firms were seeking to attract investors in to this increasingly popular sector but it was felt that the current disclosure requirements were not stringent enough to back up some of the claims being made.  This has led to the EU introducing this legislation with the key principles being:

  • Transparency and disclosure requirements on firms and products;
  • Setting parameters for determining whether an economic activity is environmentally sustainable and establishing reporting requirements if it is;
  • Introducing a new framework for climate related benchmarks; and
  • Enhancing current regulatory requirements so that sustainability risk is accounted for and sustainability factors are reviewed as part of the product governance and suitability requirements.

With the delays that have been announced this means the that firms should continue to keep these key principles in mind when reviewing its ability to comply with the Level 1 regulation and how they can evidence that this has been done on a “best efforts” basis. Equally there may be firms wishing to comply with these requirements even if not directly impacted as not making these disclosures may be viewed adversely by potential clients and/or investors.

Application of SFDR

The disclosure requirements set out in SFDR and the Taxonomy Regulation (these are the regulations which provides uniformity of terms so that there is consistency for entities when reporting their taxonomy compliance) will not enter force until after the end of the Brexit implementation period. As a result, they will not form part of retained EU law and will not be onshored by the UK government. However, given that this regulation applies to products marketed into Europe even by non-EU firms these regulations will remain relevant and indeed we now know that we should expect similar, although not the same, regulations within the UK in due course. In practice many UK “Financial Market Participants” (“FMPs”) and “Financial Advisers” (“FAs”) will have to comply with at least the Level 1 rules initially, if they wish to have access to the EU market, and then update them as necessary when the Level 2 RTS and UK regulations are confirmed. Many regulators have also set out the limitations in relation to the use of reverse solicitation for those FMP’s and FA’s that are considering relying on this exemption so firms will need to be aware of the relevant restrictions in each jurisdiction. The disclosure requirements are broad and cover products which not only claim to promote environmental or social considerations or that have sustainable investment as their objective, but also those that do not purport to promote any kind of ESG objective.

Even if firms do not claim that their products promote ESG they could still be impacted, although to a lesser degree.

Definition of sustainable investment and the ‘do no significant harm’ principle

A key feature of the new EU ESG framework, within SFDR and the Taxonomy Regulation, is that it provides a definition of sustainable investment and sets out the criteria that investee companies must meet in order to qualify as a sustainable investments.

There are two elements to this definition. Firstly, the investment must promote an environmental or social characteristic and meet minimum standards of governance. Secondly, the investment must ‘do no significant harm’ to any other area of environmental or social concern.  The Level 2 RTS was due to provide more prescriptive specification of the environmental objectives that an investment must meet in order to qualify as a sustainable investment as well as further clarify the substance of the ‘do no significant harm’ principle. Without these technical standards firms are left with the need to comply or explain in relation to the high-level standards as currently set out in the SFDR.

Disclosures at Firm and Product Level

Firm Level Disclosure

The SFDR introduces the idea of “principal adverse impact of investment decisions on sustainability factors” and requires the firm to disclose, on it’s website, how it takes the adverse impacts of investment decisions and advice into account.  These disclosures will require firms to include specific questions to investee companies as part of the firm’s investment process both in the due diligence phase and post-investment and has also been reflected in the updates to the AIFMD, UCITS Directive and MIFID.  The information required will include details on how principal adverse sustainability impacts are prioritised, brief summaries of engagement policies, reference to any adherence to responsible business conduct codes and internationally recognised standards for due diligence and reporting. Investment managers subject to MiFID must also ensure that the sustainability factors are included into their product approval and suitability processes at a sufficiently granular level to distinguish between different ESG objectives and characteristics.

These disclosures will be mandatory for firms with more than 500 employees but not for firms with less than 500 employees, although these smaller firms will need to include a statement explaining why they do not provide these disclosures.  We suspect that most firms will at least try to make the relevant disclosures given the competition in this area and the possible negative impression associated with the disclosures not being made.

Product Level Disclosure

All products must have a pre-contractual disclosure setting out how sustainability risks are integrated into investment decisions and their likely impact on the returns of the product.  Disclosures for products that specifically promote ESG characteristics will differ depending on the elements being promoted.  For instance, those products promoting environmental and social characteristics have different disclosure requirements to those promoting sustainability.  Also, where sustainability risks are deemed not to be relevant firms will also be required to explain why this is the case.  Once again, many firms will find making a statement of this type could have an adverse impact on the desirability of their product.  Whilst the granular detail that we were expecting from the Level 2 RTS will not be in force by March 2021 these disclosures will still need to be made but on a best efforts basis keeping in mind the principles driving this regulatory change.

Pre-Contractual Disclosures

Pre-contractual disclosures are also a key feature of the SFDR.  For financial products promoting environmental or social characteristics these disclosures will need to include:

  • information on how those characteristics are met (assuming that the investee companies follow good governance practices);
  • where an index has been designated as a reference benchmark, information on whether and how the index is consistent with those characteristics; and
  • information as to where than index can be found.

Pre-contractual disclosures for certain financial products that have sustainable investment as their objective and an index has been designated as a reference benchmark will need to include:

  • information on how the designated index is aligned with that objective;
  • an explanation as to why and how the designated index aligned with that objective differs from a broad market index;
  • Where no index has been designated, pre-contractual disclosures will include an explanation of how the sustainable investment objective is to be attained;
  • Where no EU Climate Transition Benchmark or EU Paris‐aligned Benchmark is available, the information must include a detailed explanation of “how the continued effort of attaining the objective of reducing carbon emissions is ensured in view of achieving the long‐term global warming objectives of the Paris Agreement”; and
  • An explanation of how indicators for adverse impacts are taken into account and how investments that cause significant harm to sustainable objectives are screened out.

In general these disclosures are still required under Level 1 and all relevant firms will need to make this disclosure on their website describing how sustainability risk is incorporated in their investment process as well how their remuneration policies are consistent with the integration of sustainability risks.

Periodic Reporting

For financial products that promote, among other characteristics, environmental or social characteristics, or a combination of those characteristics, periodic reports will need to include a description on the extent to which environmental or social characteristics are met (Article 8). For financial products that have sustainable investment as their objective, a description will need to include the “overall sustainability‐related impact of the financial product by means of relevant sustainability indicators” (Article 9). Once again, the detail for these disclosures were due to be set out in the Level 2 RTS and therefore firms will be obliged to make these disclosures in a high-level and principles-based manner.

How Can Effecta Compliance Help?

Whilst the split from the EU feels like a substantial departure with many unknowns it many regards it is reflecting the way business is being conducted and has been conducted for many years in other parts of the world.  Take the GCC for example where each country (and even within each country) there are differentiated requirements which impact cross border business.  Effecta can help you navigate this area with relevant experience as firms move in to this new regulatory environment. Effecta can provide market insight on how to manage these issues and what “best-efforts” looks like.  Specifically, we can assist with:

  • Identifying how SFDR impacts your firm.
  • Confirming what disclosures need to be made at both a firm and product level.
  • Analysing current disclosures and investment processes to identify gaps to be filled.
  • Updating policies and procedures including those relating to product governance.