In the midst of the preparation to comply with the first regulatory deadline on the Sustainable Finance agenda of the European Union –the 10 March 2021 implementation deadline of the Sustainable Finance Disclosure Regulation (“SFDR”)– the European Supervisory Authorities (“ESAs”) issued their “Final Report on draft Regulatory Technical Standards” (“SFDR RTS”) on 2 February 20212.
As the 10 March 2021 deadline has already passed, financial market participants (“FMP”) and financial advisors (“FA”)3 now need to swiftly refocus on the next important regulatory deadline on the Sustainable Finance agenda, the implementation of the afore-mentioned SFDR RTS requirements until 31 December 2021which coincides with the application date of the first two environmental objectives of the EU Taxonomy Regulation. A double regulatory jackpot of sorts.
There is a significant upside to an implementation of these regulatory provisions. Investor/client demand significantly increased for Sustainable Finance products over the last years with a further acceleration over the last 6-12 months. The entry barrier to this mainstream ESG market is compliance with the SFDR and the SFDR RTS specifically, and the EU Taxonomy regulation for dedicated strategies. Otherwise, no eligible products (art. 8 or 9 of the SFDR) can be offered to these (prospective) investors/clients, and other FMPs and FAs, who find themselves in a position to service investors/clients with sustainability preferences, will gladly fill this void.
In a nutshell, the SFDR RTS are significantly elevating the regulatory provisions for mandatory minimum sustainability disclosures. The provisions establish further requirements at entity (i.e. FMPs and FAs) as well as at product level4 (art. 8 and art. 9 SFDR products). The following is a non-exhaustive overview:
Clarification of the relationship between the “do not significantly harm” (“DNSH”) principle and the principal adverse impacts (“PAI”);
PAI statement: Periodic principal adverse impact indicators to be quantified annually; starting January 1 2022 and disclosed by 30 June 2023 for the first time (i.e. data collection throughout 2022);
Mandatory and optional list of the PAIs differentiated by the type of investment (i.e. investments into (i) companies, (ii) sovereigns and supranationals or (iii) real estate) (to be calculated across the AUM of the Entity, not just the article 8 and article 9 products);
Specification of segregated entity website section containing “Sustainability-related disclosures”. This will lead to a clear separation between sustainable and non-sustainable products on your website.
Art. 8 and 9 products under the SFDR
Mandatory template and structure of pre-contractual disclosures defined;
Mandatory template and structure of annual reports defined;
Mandatory contents and structure of product summary website disclosure t (2 A4 pages).
The implementation of the principle-based requirements of SFDR for 10 March 2021 was a significant challenge for all FMPs and FAs. SFDR RTS will set out substantially more specific requirements for FMPs and FAs promoting art. 8 and/or art. 9 SFDR products.
“Top and bottom line impact” – Strategic decision to be able to provide art. 8 or art. 9 SFDR products
FMPs that are choosing not to provide art. 8 or art. 9 SFDR products will bear less regulatory implementation costs. At the same time, those FMPs will not be able to provide products for business partners (such as initiators, distributors or other FAs) and investors/clients that have sustainability preferences. The foregone market share and future earnings are expected to substantially outweigh any regulatory implementation costs.
FMPs that have taken the decision to provide art. 8 or art. 9 SFDR products will face several key challenges in their implementation work (see examples below) and material implementation costs. A clearly defined target operating model based on a 360° business analysis will reduce implementation costs in the long run and ensure a shared vision and reduced friction losses within your organisation and any material external stakeholders.
Irrespective of any strategic product decisions, the structural change inflicted to the market will lead to opportunities for inorganic growth and change the competitive landscape.
“Talk the talk and walk the walk” – Your organisation’s Sustainable Finance expertise is a MUST have – already today
Whereas SFDR must be seen as only the tip of the Sustainable Finance iceberg, and has already been a substantial challenge for FMPs and FAs alike, SFDR RTS on its own (i.e. without taking the requirements of the EU Taxonomy Regulation into account) will influence every core process from product design, investor/client onboarding, design and handling of RfPs and portfolio management to risk management, investor/client reporting, regulatory reporting, marketing to investors/clients, delegation oversight and the internal management information system.
To understand the different evolving elements of Sustainable Finance, identify its impact on the current and future value chain of your organisation, and to accommodate the needs and demands of internal and external stakeholders alike, requires dedicated expert resources that can work across business and control functions (bird’s-eye view), and a substantial uplift of Sustainable Finance expertise for staff involved in afore mentioned core processes. This allows for a common understanding and aligned communication – internally as well as externally.
This will be specifically relevant for FMPs that must ensure all pre-contractual information for art. 8 and art. 9 SFDR products are updated to SFDR RTS standards before year-end as expectations of business partners (e.g. initiator, distributor) and operational implications for all relevant internal stakeholders must be assessed, moderated and aligned with a view to meet the expectations of business partners and investors/clients. They also need to ensure operational compliance, a tightrope act that will require significant resources and skills but can be a (further) distinguishing factor to other FMPs.
“Data is the new gold” – Never gets old, still holds true and presents a special challenge for the financial market industry
Everybody will require data and information irrespective of which products under the SFDR (non-sustainable, art. 8, art. 9) will be made available. Sustainability risk, ESG investment restrictions (e.g. ESG rating, ESG controversies other ESG indicators), sustainable investments impact assessment (e.g. measurement of positive impact and compliance with the DNSH principle in accordance to EU Taxonomy requirements or SDGs), PAI quantification , marketing information, regulatory reporting (e.g. CSSF questionnaires) or annual reporting are just some of the relevant use cases for Sustainable Finance related data.
A dedicated data strategy to define the structure of the relevant data, the data owners, interfaces to existing systems and applications aligned with the relevant use cases is the recommended starting point.
All of this doesn’t address the availability, saturation and quality of any data. A specific challenge for any investments into non-listed assets but also for listed assets that aren’t a given for the foreseeable future. So human expertise and skills will be critical to master the data challenge and distinguish from mere data providers and competitors not paying enough attention to the ESG structural transformation.
Irrespective of your current progress regarding the regulatory Sustainable Finance agenda, the following steps are relevant for a successful SFDR RTS implementation:
Review your current SFDR RTS implementation plan to ensure all relevant requirements (including the prospective SFDR RTS considering the EU Taxonomy provisions) are included, owners and dependencies identified, use cases defined, deadlines and milestones set, and institutionalised reporting ensured;
Ensure the relevant Sustainable Finance knowledge and expertise of your staff –client advisors, investment and risk managers, data scientists and, highly recommended, a dedicated ESG responsible or team;
Enhance the templates and data for transparent and periodic reporting to internal and external stakeholders (i.e. mandatory data requirements for defined use cases, consideration of data availability and collection, data processing and reporting as well as roles and responsibilities for the different aspects);
Focus on the definition of your product strategy in light of SFDR RTS and Taxonomy.
1. Final Report on draft Regulatory Technical Standards with regard to the content, methodologies and presentation of disclosures pursuant to Article 2a(3), Article 4(6) and (7), Article 8(3), Article 9(5), Article 10(2) and Article 11(4) of Regulation (EU) 2019/2088.
2. As of now the market expectation is that the SFDR RTS will enter into force on 1 January 2022 – after the usual EU legislative process has run its course. Amendments to the SFDR RTS are still possible but at this time it is expected that the main requirements remain unchanged.
3. The SFDR in principle applies to the whole regulated financial sector, e.g. credit institutions and investment firms providing portfolio management, insurance companies providing insurance-based investment products as well as management companies and alternative investment fund managers. It also applies to financial advisers.
4. The product definition under the SFDR is very wide and is inter alia including investment funds (UCITS, AIFs), insurance products, pension products and individual portfolio management mandates.
By Michael Horvath, PwC Luxembourg Sustainability Finance Team
Financial Services Leader & Sustainability Sponsor, PwC Luxembourg
Tel: +352 49 48 48 4174
Partner, Regulatory Advisory Services, PwC Luxembourg
Tel: +352 49 48 48 4131
EMEA AWM ESG Leader, PwC Luxembourg
Tel: +352 49 48 48 2040
Partner, Regulatory Advisory Services, PwC Luxembourg
Tel: +352 49 48 48 4173