European Commission provides SFDR closure

The European Commission has (finally) provided responses to questions raised by European Supervisory Authorities (ESAs) regarding SFDR back in September 2022.

The guidance represents a positive step towards providing further clarity on the intricacies of the regulation and broadly avoids a total amendment of current Article 8 and 9 disclosures.

Fund managers now have a level of closure on what is expected of them and can mostly maintain their disclosure plans.

The main updates are highlighted below.

Defining a ‘sustainable investment’

The EC has clarified that minimum thresholds for Article 9 funds will not be introduced. Rather, the definition of ‘sustainable investment’ is applicable to both the general equity or debt of an investee company, or at the level of the portfolio’s specific economic activity.

Further, it is up to individual GPs to define their own ‘sustainable investments’, but the methodology used to determine the sustainability of an investment must be explicitly provided.

Speaking with Eve Ellis, partner at Ropes & Gray, we discussed the implication of the clarifications. Ellis emphasised: “Despite the fact the guidance retains flexibility for managers in setting their sustainable investment objective, one of the points coming out of the guidance is that the regulator sees this as a big responsibility for managers and therefore the threshold for whether something is a sustainable investment should be relatively high.”

As a result, it is important that fund managers err on the side of caution and are able to disclose their conclusions.

The guidelines also clarified that transition funds do not meet the definition of ‘sustainable investment’ as they would need to comply with the ‘Do No Significant Harm’ and good governance tests from the outset.

One step further

There were further updates in relation to the PAI regime. GPs complying with the fund-level PAI regime, in addition to disclosing their PAIs, must outline the policies put in place to mitigate them.

The additional step creates a fund-level PAI regime that is more in alignment with the manager-level PAI regime requirements.

For firms unsure whether the manager-level PAI regime was mandatory for them in relation to the 500-employee threshold, the EC outlined that the definition of ‘employee’ would align with that under national law. Ellis added: “GPs will need to check the local employment law in the country where their managers are based to make this determination.”

Other key updates are as follows:

• Article 9(3) SFDR funds with the objective of reducing carbon emissions can be actively and passively managed. A detailed explanation of how the objectives are to be achieved is only necessary for actively managed funds – those that do not track the Paris-Aligned Benchmarks or Climate Transition Benchmarks.
• Funds can promote carbon emissions reductions under Article 8, but must ensure that any wording is not misleading to suggest a sustainable investment objective.
• MiFID firms with portfolio management services required to produce quarterly reports are only required to provide SFDR reports for Article 8 and 9 funds annually in the fourth report of the year.

The responses provided by the EC are the next step in the SFDR saga, following on from the ESA’s consultation paper on the proposed Regulatory Technical Standards, with responses due by 4 July 2023.