The Sustainable Finance Disclosure Regulation (SFDR)1 empowered the European Supervisory Authorities (ESAs)2 to develop draft regulatory technical standards (RTS) on taxonomy-related product disclosures. On 15 March 2021, the ESAs published a consultation paper on draft regulatory technical standards regarding the content and presentation of sustainability disclosures pursuant to Article 8(4), 9(6) and 11(5) of the SFDR (the March Taxonomy RTS). The March Taxonomy RTS made amendments to the RTS that the ESAs published in February 2021 in respect of for the SFDR, (the SFDR RTS).3 The ESAs decided to amend the SFDR RTS instead of creating a new ruleset, with the aim of minimising duplication and complexity in this area. The ESAs’ aim is to have the RTS on disclosures rules function as a “single rulebook” for sustainability disclosures at Level 2 for both the original empowerments in SFDR and the additional ones added by the Taxonomy Regulation.
October Taxonomy RTS).4 In this OnPoint, we will provide an overview of the main changes that the October Taxonomy RTS introduced as compared to the original proposals set out in the March Taxonomy RTS.
The EU Commission will scrutinise the October Taxonomy RTS and decide whether to endorse them within three (3) months of their publication. The EU Commission has informed the European Parliament and Council that it intends to incorporate all the SFDR RTS, meaning the SFDR RTS submitted to the EU Commission in February 2021 as well as the October Taxonomy RTS, in one instrument.
The date of application of the October RTS is stated as 1 January 2022, however, the ESAs have noted that the EU Commission is expected to adopt the single RTS instrument with an application date of 1 July 2022. This six-month delay is in line with what the ESAs suggested in their letter dated 8 July 2021.5
1. Disclosure of the environmental objectives contributed to
The October Taxonomy RTS cover the content and presentation of the additional information to the SFDR product disclosures where the product makes sustainable investments that contribute to an environmental objective. The ESA have amended the March Taxonomy RTS to make it clear that there are certain subsets of financial products that promote environmental or social characteristics (Article 8 Products) or that have sustainable investment as their objective (Article 9 Products).
Article 8 Products can accordingly be categorised follows:
- Article 8 Products that promote environmental or social characteristics but that do not make sustainable investments;
- Article 8 Products that make sustainable investments with an environmental (or social) objective; and
- Article 8 Products that make sustainable investments with an environmental objective and at least some of those sustainable investments that meet the requirements of Article 3 of the Taxonomy Regulation (i.e., that are taxonomy-aligned).
With regards to Article 9 Products, the subsets can be viewed as:
- Article 9 Products that make sustainable investments with an environmental (or social) objective; and
- Article 9 Products that make sustainable investments with an environmental objective and at least some of those sustainable investments are taxonomy-aligned.
This provides some welcome clarity as to how to disclose certain information, and indeed whether disclosures are necessary given a particular product’s characteristics.
In addition, it is worth noting that the content requirements of the mandatory templates for Article 8 Products and Article 9 Products in relation to taxonomy-alignment have been clarified.
2. The extent to which investments are taxonomy-aligned
There is a requirement to provide both pre-contractual and periodic disclosures as to the extent to which the investments that products invest in qualify as environmentally sustainable under the Taxonomy Regulation. As was the case with the March Taxonomy RTS, the October Taxonomy RTS propose that the pre-contractual disclosures of the extent of the taxonomy-alignment are to be shown by way of a graphical representation in the form of a pie chart of a key performance indicator (KPI).
However, the October Taxonomy RTS specify that the default KPI for the purpose of calculating the taxonomy-alignment of investments in non-financial undertaking is turnover. It is possible, however, to use an alternative KPI- namely capital expenditure (CapEx) or operational expenditure (OpEx) – if the features of the financial product mean that CapEx or OpEx would be more appropriate and would give a more representative calculation of the taxonomy-alignment. Unlike the March Taxonomy RTS, the October Taxonomy RTS do not state that the same KPI must be used across all investment in non-financial undertakings. For the sake of completeness, it is worth mentioning that the calculation of the taxonomy alignment of investments in financial undertakings is set out in delegated legislation pertaining to Article 8 of the Taxonomy Regulation.6
By contrast, the periodic disclosure of the taxonomy-alignment of investments in non-financial undertaking are to be shown in a graphical representation of all three KPIs – turnover, CapEx and OpEx – irrespective of the KPI that is used in the pre-contractual disclosure.
3. How the investments are taxonomy-aligned – “do no significant harm”
To recap, there are essentially two different principles of “do no significant harm” (DNSH) – one under SFDR and the other under the Taxonomy Regulation. Article 2a of the SFDR provides a basis for the ESAs to develop a methodology around DNSH that are consistent with those provided for in relation to the adverse impact indicators set out in Annex 1 of the SFDR RTS. In contrast, the DNSH requirement as set out in the Taxonomy Regulation states that to establish the degree to which an investment is environmentally sustainable, an economic activity must not significantly harm any of the environmental objectives set out in Article 9 of the Taxonomy Regulation as specified in the Taxonomy Climate Delegated Act7 setting out the technical screening criteria for the environmental objectives. In the March Taxonomy RTS, the ESAs had proposed to derogate from the general SFDR DNSH principal for taxonomy-aligned investments on the basis that the taxonomy-aligned investments would already be subject to the Taxonomy Regulation’s DNSH principle. However, as result of further legal analysis, the ESAs have concluded that it is not possible to derogate from the general SFDR DNSH principle for taxonomy-aligned sustainable investments. Consequently, the DNSH SFDR related requirements will apply to all sustainable investments - including taxonomy-aligned ones.
4. Treatment of Sovereign Bonds
The ESAs decided to require the disclosure of the taxonomy-alignment of investments in two ways in relation to their treatment of sovereign bonds: one including sovereign exposures8 and one excluding sovereign exposures from the calculation. The ESAs took this step in recognition of the fact that there is a current lack of an appropriate calculation methodology for sovereign exposures and financial market participants “cannot assess the extent to which those exposures contribute to taxonomy-aligned economic activities.”
The October Taxonomy RTS accordingly contain a graph that includes all the investments of the financial product in the calculation, and a second graph showing the taxonomy-alignment of the financial product where all sovereign exposures are excluded from the calculation.
5. Consideration (or not) of Principal Adverse Impacts
The October Taxonomy RTS provide some welcome clarity on principal adverse impact statements to be provided pursuant to Article 7 of the SFDR. Specifically, there had been some uncertainty as to whether principal adverse impact statements were required for Article 9 Products. The drafting of certain provisions of the March Taxonomy RTS indicated that for Article 8 Products the requirement was to explain “whether a financial product” considers principal adverse impact, but for Article 9 Products the requirement was to “explain that the financial product contributes to a sustainable investment objective by considering principal adverse impacts” – implying that it was a requirement for Article 9 Products to make the principal adverse impact statements (something not actually stipulated in the Level 1 text of the SFDR).
The October Taxonomy RTS have been amended so that Article 9 Products need to explain “whether the financial product considers principal adverse impacts on sustainability factors,” clarifying that it is not mandatory for Article 9 Products to provide a principal adverse impact statement. Associated amendments have been made to the mandatory template.
The October Taxonomy RTS provide some welcome clarity with regards to the required disclosures, but the level of detail that financial market participants will be obligated to provide remains extensive. The market is watching with interest and hoping, and indeed anticipating, that the EU Commission will agree to delay the application of all the RTS until 1 July 2022. On a practical level, failure to delay the application of the RTS will severely impact in-scope financial market participants and products who will have less than two months to adapt their systems, procedures and disclosures to comply with these more granular requirements.
It is important to note that any delay to the RTS will not impact on the application of the Level 1 text of the Taxonomy Regulation – these provisions will ‘go-live’ on 1 January 2022.