Risk & Compliance

Level II SFDR: pre-contractual disclosure

In January 2021, the European regulators (ESAs) published their final proposed regulations to further flesh out the Sustainable Finance Disclosure Regulation (SFDR), known as Regulatory Technical Standards (further SFDR RTS). That publication kicked off a series of blogs on the various components of this SFDR RTS. Earlier, we discussed the do no significant harm principle and the consideration of adverse effects on sustainability factors.

This time, we turn to pre-contractual disclosure. Because the SFDR RTS also has extensive requirements for that information.

Date:October 11, 2021

Pre-contractual information is not always pre-contractual

Before going into the substantive requirements of the SFDR, we would like to point out that the term ‘pre-contractual information’ is a bit misleading. Indeed, the term implies that it refers to information provided by the company before the provision of services starts.

However, this need not be the case. The SFDR prescribes for each financial product in which document the pre-contractual sustainability information must be included. In the case of an investment institution, for example, this must be in the prospectus or the Information Memorandum. Surprisingly, the SFDR also lists here documents that are not necessarily provided prior to the provision of services. For example, the pre-contractual sustainability information for a pension scheme must be included in the Pension 1-2-3, while members often receive the Pension 1-2-3 only after they join a pension scheme.

In short, it is important to consider in time how and when your company should provide pre-contractual sustainability information.

Grey products – no action needed?

First of all, it is good to know that the requirements of the SFDR RTS are not the same for every financial product. In general terms, the more sustainable the product, the more information needs to be provided.

If your company offers a ‘grey’ product (a product not covered by Articles 8 or 9 of the SFDR), no additional pre-contractual information requirements will become applicable on 1 July 2022 under the SFDR.

Nevertheless, we recommend that you mark the date of 1 July 2022 in your diary. In addition to the SFDR, there is also the Taxonomy Regulation from which there are obligations relevant to grey products. Indeed, as of that date, for grey products, that Regulation requires you to include the following in pre-contractual information:

“The underlying investments of this financial product do not take into account the EU criteria for environmentally sustainable economic activities.”

Sustainable products – one size never fits all

If your product falls under article 8 (light green) or article 9 (dark green), there is significantly more work to be done. You will then be expected to fill in a four-page form, answering questions such as:

  • What kind of investment strategy does this product follow?
  • What are the binding elements of the investment strategy that will ensure that the sustainability features/objectives will be achieved?
  • How will investments for this product be allocated (what percentage will be ‘sustainable’ and what percentage will not)?
  • How is it assessed whether investee companies follow good governance practices?

In addition, companies offering sustainable products must indicate the extent to which their investments are in line with the Taxonomy Regulation.

The questions in the template are quite detailed. As such, companies will need to free up the necessary capacity and resources to formulate the answers. And: they will need to have the necessary data.

This is not yet that easy. The AFM therefore warns parties: make sure the sustainability targets or characteristics are carefully formulated, so that the results achieved can also be measured in the future. And: be aware that you may depend on other parties in the investment chain (such as external asset managers) and data suppliers for the provision of information.

Already in the consultation paper for the SFDR RTS, the ESAs had indicated that it would be a huge challenge to develop one template to fit all the pre-contractual information documents listed in Article 6(3) of the SFDR, such as, for example, a prospectus or a Pension 1-2-3. Unfortunately, there was no room to develop different templates; the ESAs were obliged to develop one uniform pre-contractual product template.

ESAs now indicate in the SFDR RTS that they have chosen a template with a balance between comprehensibility and comprehensiveness. In other words, between comprehensibility and comprehensiveness.

It remains to be seen whether this is successful. Not only are the products for which the template is to be used diverse; so are the readers. An institutional investor looking to invest in an investment vehicle might be willing to peruse the prospectus including the pre-contractual SFDR template, but whether the same is true for the average consumer is highly questionable. Similarly, a consumer who receives a Pension 1-2-3 because he/she is a mandatory member of a particular pension fund will be less inclined to take in all the sustainability information. For that consumer, the addition of a template with four sides of sustainability information seems a bit over the top.

Again, use of the template is mandatory and the questions in the template are always the same. While this increases the comparability of the information, it also deprives companies of the space to tailor the disclosure to the specific product and readership. All this shows that it is extremely difficult to lump all types of financial products together: one size never fits all.

Want to learn more?

Do you have any questions following the above information? Could you use support in identifying or implementing (upcoming) ESG regulations, such as the SFDR? We would be happy to tell you more about ESG regulations for the financial sector, and their impact on your company. Contact us for more information.