Regulation 2019/2088 – Where do we stand?

What is the regulatory context? 

Regulation 2019/2088 on sustainability-related disclosures in the financial services sector (SFDR) lays down harmonized rules on the transparency expectations investors will have to abide by when integrating sustainability risks and considering sustainability-related adverse impacts in their processes.

In April this year, draft Regulatory Technical Standards (draft RTS) were published by the Joint Committee of European Supervisory Authorities (ESAs). The draft RTS bring more precision to the content, methodologies, and presentation of sustainability-related disclosures. In particular, it requires financial market participants (FMPs) to annually issue a statement disclosing the principle adverse impacts (PAI) of their investment decisions on sustainability factors. This particular part on PAI statements in the draft RTS received severe criticism from the industry and the final version of the RTS, which is expected to be released in the first quarter of 2021, might thus be changed from its current formulation.

This briefing highlights the difference between sustainability risks and adverse sustainability impacts and provides an update on the current status of the related regulatory requirements.

What is the difference between sustainability risks and adverse sustainability impacts?

Article 2 (22) of the SFDR defines sustainability risk as an environmental, social, or governance event or condition that, if it occurs, could cause an actual or a potential material negative impact on the value of the investment.

Recital 20 of the SFDR defines principle adverse impacts (PAI) as impacts of investment decisions and advice that result in negative effects on sustainability factors, which are defined in article 2 (24) of the SFDR as environmental, social and employee matters, respect for human rights, and anti‐corruption and anti‐bribery matters.

The key difference between these terms relates to their different risk perspectives:

• An analysis of sustainability risks focuses on risks that can impact the value of a financial product. For example, a mining company destroying an aboriginal site because of insufficient due diligence processes might lead to a decrease in its long-term value due to a decrease in investor confidence, brand value, etc.
• An analysis of adverse sustainability impacts has an outward facing approach as it focuses on the negative impacts caused by financial products and services on the environment and society. For instance, a commodity company importing soy from the Amazon without proper traceability might inadvertently import a product obtained through illegal land clearance. Investing in such a company might thus contribute to a negative impact on the environment, materializing in deforestation and endangerment of protected species. The main challenges in assessing adverse sustainability impacts are that these are not necessarily perceived as financially material and their financial impacts are realized over longer time scales.¹

What are the next steps? 

A letter from the EU Commission addressed to the German Investment Funds Association and the Italian Investment Management Association was published recently and provided more clarity on the deadlines for the SFDR and the RTS applicability:

• All application dates of the SFDR will be maintained. Consequently, financial market participants and financial advisers will need to comply with this regulation’s high-level and principle-based requirements in 2021.
• The detailed disclosure requirements under the RTS will become applicable at the beginning of 2022.

If you`d like more information on the content, regulatory basis, or deadlines of the different disclosure obligations required by SFDR and the draft RTS regarding sustainability risks and PAIs, do not hesitate to reach out to us.