On 6 July 2021 the European Commission adopted the much-awaited decision C(2021) 4858 final (the “Decision”) which provides, in its annex, very useful answers to the questions raised by the European Supervisory Authorities (i.e. the EBA, ESMA and EIOPA) in their letter dated 7 January 2021 on priority issues relating to the application of the Sustainable Finance Disclosure Regulation (“SFDR” or “Level 1 requirements”).
The European Commission (“EC") answers available here confirm, in particular, the “extraterritorial" effect of the SFDR (1), its neutrality in terms of financial products design (2), and clarify the concept of “promotion" of environmental, social, and governance (“ESG") characteristics (3). Nevertheless, according to the EC, these answers only clarify provisions already contained in the applicable legislation. They do not extend in any way the rights and obligations deriving from such legislation, and as reminded by the EC in a letter accompanying the Decision, only the Court of Justice of the European Union is competent to authoritatively interpret Union law. The EC also cautiously notes that the views expressed in the Decision do not prejudge the position it might take before the Union and national courts. The aforementioned evidences all questions of interpretation that could be raised around the SFDR, especially with regard to the forthcoming adoption of the SFDR regulatory technical standards (“RTS" or “Level 2 requirements") due to apply as from 1 July 2022, are still far from being answered (4).
1. SFDR “Extraterritorial" Effect
First of all, the EC confirms the “extraterritorial" effect of the SFDR as regards non-EU alternative investment fund managers (“AIFMs") carrying out their activities within the European Union (“EU"). It has notably been clarified that where an AIFM from a third country enters the market of a given Member State by means of a national private placement regime, that AIFM must ensure compliance with the SFDR, including the financial product related provisions.
Similarly, the EC confirms that the 500-employee criterion (as laid down in Article 4(4) of the SFDR[i]) relates to large groups in their entirety. According to the EC, the calculation of the headcount takes into account the number of employees of a parent undertaking and of subsidiary undertakings regardless whether they are established inside or outside the EU.
This approach is not surprising, especially taken into consideration the answer provided by the
EC and the Technical Expert Group on Sustainable Finance in the EU Taxonomy & EU Green Bond Standard FAQ available here (see page 10 of the FAQ). Indeed, in the same way as the Taxonomy Regulation, the SFDR should apply to all non-EU financial market participants (“FMPs") and financial advisers (“FAs") offering financial products or advice on financial products marketed in the EU regardless of where the manufacturer or adviser of such products are based. Furthermore, this in line with the general approach regarding the extraterritorial effect of EU law as regards third country firms operating in the EU internal market, as it is the case, for example, in EU competition law matters.
2. Neutrality in terms of Financial Products Design
In addition, the EC confirms that Article 8 and Article 9 SFDR requirements remain neutral in terms of product design. They do not prescribe certain elements such as the composition of investments or minimum investment thresholds, the eligible investment targets, and neither do they determine eligible investing styles or tools, commercial strategies or methodologies to be employed.
Rather, SFDR sets out harmonised transparency rules at EU level in order to address potential issues of greenwashing by financial products, i.e. preventing FMPs to provide false impressions or misleading information about how a financial product is intended to and is effectively performing in terms of ESG sustainability.
3. Concept of “Promotion" of ESG Characteristics
Furthermore, the EC provides in the Decision useful interpretation tools regarding the concept of “promotion" referred to in Article 8 of the SFDR and clarify the distinction between Article 8 and Article 9 products, which are two distinct product categories.
On the one hand, the EC recalls that Article 9 products are the financial products which exclusively have sustainable investment as their objective.
On the other hand, the EC recalls that Article 8 products are the financial products which promote environmental or social characteristics or a combination of them, provided that the companies in which the investments are made follow good governance practices.
Interestingly the EC sets out new interpretation criteria regarding such second products. According to the Decision, the promotion of ESG characteristics means that (i) where a financial product complies with certain environmental, social or sustainability requirements or restrictions laid down by law (including international conventions, or voluntary codes), and (ii) these characteristics are “promoted" in the investment policy, such financial product fall within the scope of Article 8 of the SFDR.
In very broad terms, the EC explains that the term “promotion" within the meaning of Article 8 of the SFDR encompasses, “by way of example, direct or indirect claims, information, reporting, disclosures as well as an impression that investments pursued by the given financial product also consider environmental or social characteristics in terms of investment policies, goals, targets or objectives or a general ambition in, but not limited to, pre-contractual and periodic documents or marketing communications, advertisements, product categorisation, description of investment strategies or asset allocation, information on the adherence to sustainability-related financial product standards and labels, use of product names or designations, memoranda or issuing documents, factsheets, specifications about conditions for automatic enrolment or compliance with sectoral exclusions or statutory requirements regardless of the form used, such as on paper, durable media, by means of websites, or electronic data rooms".
According to the EC, nothing prohibits financial products that fall under Article 8 to be in part invested in “sustainable investments" (as defined in Article 2(17) of the SFDR), but it would also be possible that such products do not invest in sustainable investments and only promote ESG characteristics as defined above (i.e. certain environmental, social or sustainability requirements or restrictions laid down by law promoted as part of the investment policy of the product).
Therefore, as the EC stresses it, Article 8 products have a lower sustainability-related ambition than the ambition of financial products subject to Article 9, but ESG characteristics promoted by such products are an important aspect of the concerned investment and asset allocation processes.
4. Next Developments to Follow
If the Decision provides useful answers and interpretation tools, it is not the end of the SFDR's regulatory journey and the forthcoming new EU law rules as part of the EC renewed sustainable finance strategy. Another important piece of legislation that should be adopted in the coming months is also the SFDR RTS. From a single RTS proposed by the ESAs on 4 February 2021, the EC now plans to bundle 13 various sustainable finance related regulatory technical standards in a single extended RTS which should apply as from 1 July 2022 and will have to be carefully analysed and implemented by all concerned actors.
A continuous regulatory watch is definitely necessary, more than ever, for all FMPs and FAs involved in this field and we will keep you regularly updated in that respect.
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[i] With respect to the publication on websites of large FMPs of a statement on their due diligence policies with respect to the principal adverse impacts of investment decisions on sustainability factors.