Risk & Compliance

The SFDR and the Taxonomy Regulation: (comply or) explain 

Date:September 27, 2023

In recent months, we have published a series of articles on the various components of the SFDR Regulatory Technical Standards (SFDR RTS), also known as Level II SFDR. 

Finally, on 22 October 2021, the European Supervisory Authorities (ESAs) published their ”Final Report on Draft Regulatory Technical Standards”. What is the relationship between the SFDR RTS and the Level 1 Taxonomy Regulation, which comes into force on 1 January 2022? And how can you prepare for it? 

Final publication level II SFDR 

The final RTS SFDR aims to achieve a “one single rule book” for sustainability-related information. A “one single rulebook” you basically have with this publication. In fact, a consolidated text is attached. However, for the complete picture, you still need to put some pieces of the puzzle together yourself. For instance, you have to conjure up the template for the PAI Statement as well as the explanatory notes from an earlier version. This draft RTS contains the requirements and explanatory notes for pre-contractual as well as periodic product disclosures, both for the information you need to publish under the SFDR and the information from the Taxonomy Regulation (TR). 

The original effective date of the RTS for the SFDR was 10 March 2021. This was postponed to 1 January 2022 last year via a Supervisory Statement. Subsequently, by letter dated 8 July 2021, the European Commission (EC) indicated that 1 January 2022 had also proved unfeasible. Therefore, the entry into force has now been postponed again, to 1 January 2023. 

Until then, we recommend that you fill in the templates for Articles 8 and 9 SFDR, which can be found in this RTS, as a trial. An advance warning: you may encounter problems in doing so. Applying the comply or explain principle may be helpful here, with the emphasis most likely to be on explain. 

Taxonomy regulation level I 

Besides the entry into force of the draft RTS, there is another important issue: the entry into force of the level I text of the TR. The hope and expectation was that by now – whether through this draft RTS or not – there would also be clarity on how you should deal with product-level obligations under level 1 TR. Indeed, the TR requires you to publish product-related information as early as 1 January 2022, and pay close attention to whether it says TR or SFDR after the article: 

Grey products 

Article 7 TR requires that for grey products under the SFDR, the Article 6 SFDR products, a mandatory standard sentence must be added to the pre-contractual information. This sentence indicates that this product does not include investments that meet the requirements of the TR. 

Light green and dark green products 

Article 5 of the TR requires that for Article 9 SFDR products that invest (in part) in economic activities that contribute to climate mitigation or climate adaptation, additional information must be included in the pre-contractual information. In short, the extent to which there is an “environmentally sustainable activity” under the TR must be indicated (also called Taxonomy-aligned). 

For Article 8 SFDR products that also make sustainable investments and (for part of them) invest in economic activities that contribute to climate mitigation or climate adaptation, you must also include that additional information. This is because Article 6 TR stipulates that Article 5 TR applies to these products. So the extent to which there is an “environmentally sustainable activity” under the TR must also be indicated for these products. In addition, all Article 8 SFDR products have to include a mandatory sentence in the pre-contractual information under the TR just like grey products, only more extensive. 

The problem? You have to provide disclosures for light green and dark green products, while the screening criteria to determine the extent of an environmentally sustainable activity are not yet final. 

In addition, a lot of companies (investee companies) from whom you have to collect the required information are not (yet) obliged to provide (you) with that information. For instance, because the company is not listed, has fewer than 500 employees or is not based in Europe. 

But a mismatch also arises for those companies that do have to publish that information. While on 1 January 2022 you will have to start disclosing which activities are Taxonomy aligned, on 1 January 2022 the companies (in which you invest) will only have to disclose whether they are Taxonomy-eligible. Taxonomy eligible? Yes, taxonomy eligible! 

Without going into too much detail… Taxonomy eligible is a less far-reaching requirement; something like “it could well be that this will soon also be taxonomy aligned – requirement”. Not until 1 January 2023 at the earliest will these companies have to declare whether the activities are actually Taxonomy-aligned. 

How can you comply with this requirement? 

One solution could be to use estimates, or “estimates”. The draft RTS as quoted above states that when data is not yet available, you may use data from third parties, including data providers. These data providers will equally well be forced to use estimates at the moment the required data is not (yet) available. 

Another frequently heard alternative, when making this requirement transparent, is to indicate that it does not include investments that are taxonomy aligned, i.e. 0%. Strictly speaking, this can also be misleading. Because whether that is the case is as impossible to determine as the opposite. 

Our advice? Whichever of the above mentioned solutions you choose, make sure you are straightforward. State why you have used estimates or why you are reporting 0%. Make it clear what information is still missing for compliance with the requirements of the TR and at the same time state that, once the information is available, you will publish it (and keep that promise). So again, we recommend you apply the comply or explain principle. Or shall we call it the explain principle from now on? 

Want to know more? 

Could you use support in identifying or implementing (upcoming) ESG regulations, such as the SFDR and Taxonomy Regulation? We would be happy to tell you more about the requirements and their impact on your company. Feel free to contact us without any obligation.