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SMSG advice on ESG disclosure

Securities and Markets Stakeholder Group

14 September 2020



SMSG advice to the ESA’s Joint Consultation Paper on ESG Disclosures (draft reg- ulatory technical standards with regard to the content, methodologies and presen- tation pursuant to Article 2a, Article 4(6) and (7), Article 8(3), Article 9(5), Article

10(2) and Article 11(4) of Regulation EU 2019/2088 .

I . Executive summary

The SMSG believes that the synergy between different pieces of legislation (in particular the Non- Financial

Reporting Directive (NFRD), the Taxonomy Regulation, and the Sustainable Finance Disclosure Regulation

(SFDR), but also adjacent legislation such as the Shareholders Rights Directive II and the scheduled reviews

of MiFID and UCITS/AIFMD) can contribute significantly to enhancing sustainability in the economy . How- ever, neither the timings nor the concepts of these different pieces of legislation are fully synchronized or

aligned with one another . The SMSG believes in the usefulness of setting a significant step forward now,

while enabling the possibility of an iterative process resulting from the interaction between the different

pieces of legislation .

To optimally exploit this synergy, enhance effectiveness of the different pieces of legislation and maintain

simplicity, the SMSG believes in the usefulness of an iterative process between these different pieces of

legislation, probably for at least two-three years . This could be organized to culminate with the scheduled

review of the SFDR end 2022 . However, to allow sufficient degrees of freedom for the iterative process, the

SMSG suggests a phased approach with regard to the draft RTS . This is particularly relevant for the pro- posed set of mandatory reference indicators to describe adverse impact . It is feared that introducing these

indicators in a ‘Big Bang’ would set path dependency, which makes it difficult to finetune them at a later

stage .

The SMSG believes it is important to set a first step forward . In this respect, it notes that the draft RTS

entail many aspects such as the use of a format, the description of policies, engagement etc . Among all

these is also the use of descriptive indicators . It is on the latter that the discussion is focused . The SMSG

contests the use of an extended set of indicators for the following reasons:

• There will be a problem of data availability for a substantial period to come

• The proposed set requires fine- tuning, which could possibly come by as a result of the iterative

process described above . However, there is a risk that introducing these indicators in a one-off Big

Bang seals the possibility for later adjustments .

An alternative could for example be to start with a much smaller core set of reference indicators to be used

whenever relevant following a comply or explain mode, while maintaining the policy indicators . Over time,

this set could possibly expand .

ESMA • 201-203 rue de Bercy • CS 80910 • 75589 Paris Cedex 12 • France • Tel . +33 (0) 1 58 36 43 21 • www . esma . europa . eu

While it is useful, as a common toolbox for cross-sector non-financial analysis and as input to the review of

the NFRD, to suggest, already at this stage, a set of potential reference indicators, the SMSG believes in

the need to finetune them . This toolbox should also be viewed as a common language between inves- tors/analysts on one side and issuers on the other . The dialogue with issuers is paramount to reach mean- ingful transparency and the establishment of indicators should not pre-empt the review of the NFRD .

The present proposals reflect the status of the current political decision making in the EU . As such, the

Social indicators (for which the ESA mandate provides a later deadline) are underdeveloped as compared

to the Environmental indicators . While the SMSG values that the ESA’s try to insert indicators for Govern- ance into the draft RTS, through for example the indicators for ‘social and employee matters’, it regrets that

Level 1 legislation has not given them an explicit mandate to develop Governance indicators .

One of the reasons for development of the SFDR was the need for comparability of information disclosed

to investors . Regarding this, the SMSG would like to point ESA’s attention to the issue of precise definitions

of particular indicators . The definitions of particular indicators provided in the draft RTS may have precise

names, but they need to be accompanied by detailed instructions as to what data need to be used to calcu- late these indicators . Without these instructions companies may provide financial institutions with data as

seems appropriate to the companies and that would result in incomparability of data from different Member

States .

On a conceptual level, the SMSG questions the usefulness of an extended set of descriptive indicators at

entity level, as the most relevant level for the investor is the product level . Also, the SMSG believes that the

relevance of individual indicators may vary depending on the type of product . However, if one allows a

degree of flexibility, one should also demand transparency and disclosure regarding this flexibility . For this

reason, the SMSG suggests that:

the field “description of policies to identify and prioritise principal adverse sustainability impacts”

(template under article 4), should disclose (i) which criteria are used to select and prioritize indica- tors for adverse impact at product level and (ii) the process (governance) through which this done .

• Specifically for art . 8 and 9 products, the templates (still to be developed) should disclose why par-

ticular indicators are used and why others are not .

The SMSG asks the ESA’s and the Commission to take their responsibility and provide more clarity on what

exactly is meant by article 8 and 9 products . Given the wide range of products that could possibly fit under

article 8, transparency about the degree of sustainability is important . Hence a graphic representation illus- trating the degree of sustainability is useful, combined with a narrative which is simple and straightforward .

In this respect, it is also important that there is consistency between marketing communication and website

information /precontractual disclosure . The SMSG points at the possibility (article 13, draft RTS) for the

ESA’s to ensure this consistency through draft RTS . For reasons of simplicity, the SMSG proposes to

integrate the warning referred to in draft article 16(1) in the narrative accompanying the graph and reformu- late it accordingly, with reference to the graph (for example: “only the part indicated in the graph … promotes

environmental or social characteristics”) . Also, the SMSG suggests to reinforce the link between the Tax- onomy Regulation and the Sustainable Finance Disclosure Regulation with regard to sustainable invest- ment .

With regard to the use of adverse impact indicators at product level, the SMSG notes that many of the

concerns at entity level, are also relevant at product level: timing problems with regard to the availability of

data, problems of materiality (relevance of indicators differs across products) and proportionality, the need

to allow an iterative process rather than seal the indicators through a “Big Bang” at too early a stage, the

need to consider qualitative considerations in the assessment of adverse impact, rather than merely quan- titative ones (example: thresholds) . The SMSG calls on the ESA’s to consider alternative approaches, keep- ing these considerations in mind .


I . Bridging the gap between theory and practice

1 . The SMSG is aware of the context in which it writes its advice: daunting economic and social challenges

on a global scale resulting from the COVID-19 crisis; unprecedented environmental threats, in particular

climate change . Against this background, enhancing the Environmental, Social and Governance (ESG)

inclination of the economy has a valuable role to play . Also, it can increase the appeal of entrepreneur- ship and investing as being part of the solution .

2 . Financial legislation alone cannot adequately deal with these challenges . Nevertheless, disclosure has

its role to play . As such, the SMSG is aware of the unique opportunity arising at this point in time, in

particular by the potential synergy between the Sustainable Finance Disclosure Regulation (SFDR) and

the Non-Financial Reporting Directive (NFRD) .

3 . To fully exploit this potential, the gap between theory and practice should be bridged . In this respect,

well-balanced regulatory technical standards guiding the implementation are of utmost importance .

a .

“Go forward, but mind the steps” . The SMSG’s principal worry is the timing, which is con- sidered to be unrealistic for several reasons:

i . There will be a time lag between the review of the Non-Financial Reporting Di-

rective and the implementation of the Sustainable Finance Disclosure Regulation .

However, the former is a prerequisite for the latter, as its review is needed to facil- itate data availability . Reliable data are important to enhance the credibility of the

SFRD . The SMSG cautions not to jeopardize the potential of this legislation by

timings that do not take into account data constraints . Inasmuch as a primary pur- pose of the NFRD review will be to identify which indicators should be to standard- ized on cross- sector basis (taking into account principle of materiality), the pro- posed set of indicators should not pre-empt this complex analysis .

ii . The implementation of SFDR will require additional costs and resources for data

collecting and reporting from issuer-companies . This will be particularly so for

SME’s, who are at this stage less acquainted with ESG reporting . However, the

Sustainable Finance Disclosure Regulation was approved in pre-COVID-19 times .

Today, many companies, including SME’s are struggling for survival . As such, the

timing imposed by the SFDR requires a ‘new-reality’ check .

iii . The indicators put forward by the ESAs are addressed to investors (financial market

participants) to allow them to assess the principal adverse impacts of their invest- ment decisions (or financial advice) . These indicators will directly impact reporting

of non-financial information by issuers and when the data will not be available, fi- nancial market participants will turn to investee companies to collect all necessary

information . All reporting requirements should be dealt with in the context of the

review of the Non-Financial Reporting Directive (NFRD) and ensure consistency of

the reporting framework for issuers with the Taxonomy Regulation .

iv . Article 7(2) of the draft RTS implies that the principal source of information relevant

to the disclosures should be gathered through direct engagement with investee

companies . Where “best efforts” have been insufficient to gather the necessary

information from the investee company, an asset manager may resort to “third- party data providers”, conduct additional research or make “reasonable assump- tions” . As the data required to calculate adverse impacts according to the indicators

is, at this early stage, in most cases unattainable directly from investee companies,

entities subject to the disclosure requirements risk developing a dependence on

third- party data providers that claim to have access to the necessary information .

Hence, there are legitimate concerns that pursuing the Big Bang approach


represented by these draft RTS will trigger a “race to the bottom” among third- party

data providers as they scramble to offer data that purport to cater to the needs of

asset managers arising from the disclosure requirements . For their part, asset man- agers harbour serious concerns regarding the reliability, accuracy and robustness

of the data offered by third-party providers that relates to indicators for which data

is not available or readily attainable from investee companies .

v .

the 32 core indicators put forward by the ESAs will add up to the indicators laid

down in the Taxonomy Regulation (sustainable proportion of turnover, capital ex- penditure and operating expenditure) and to the KPIs that will come out of the re- view of the NFRD

4 . Notwithstanding these remarks, the SMSG believes it is important to move forward, but rather than a Big

Bang approach, it suggests a phased approach (see below) .

5 . There is scope for crossfertilisation between different pieces of legislation, in particular the SFDR, the

NFRD and the Taxonomy Regulation . As such, the SMSG’s plea for a phased approach should allow

for an iterative interaction between different sets of legislation .

6 . Investors require comparability, simplicity and reliability . Each of these concerns will be kept in mind

throughout this advice . The consultation acknowledges the need for disclosure that is easy to use and

refers amongst others to the use of templates . While not all templates were ready at the time of the

consultation, the SMSG points at the importance of them being consumer tested . Particular challenges


a . How to cope with the difference in precontractual disclosure between UCITS and occupa-

tional pensions, resulting from Level 1 legislation;

b . How to device the template so that aside of the quantitative indicators, attention is also

drawn to how financial institutions/products go along with these realities (for example: en- gagement through (proxy) voting);

7 . “In der Beschränkung zeigt sich der Meister” . A major concern is data overload for both the investor

who needs to understand and the financial advisor who needs to explain . This is particularly so for the

high number of data to screen against the proposed adverse impact indicators . This also invokes the

question: at which level are data most relevant: at an overall level encompassing all products or at prod- uct level, taking into account the specificities of the product (for example: SME vs large cap funds; sec- toral differences…) .

8 . Materiality and proportionality . Taking into account on the one hand the risk of data overload, on the

other hand the challenges of data availability, the SMSG suggests to look more deeply into the matter of

materiality and proportionality .

a . Materiality: the SMSG doubts the relevance of 32 mandatory indicators to assess principal

adverse impact . In particular, the SMSG wants to discuss the relevance of aggregating

these indicators over all relevant products of a financial institution (see below) . Moreover,

an extended set of mandatory indicators may not necessarily increase the relevance . The

longer the list of mandatory indicators, the less scope there is for adding optional indicators,

without increasing the data overload . However, these optional indicators may be relevant

for specific products . This then raises the issue of the appropriate level of using indicators

and related to that, the relation between SFDR art 4, 7, 8, 9 (see below) .

b . Proportionality: the extended set does not allow for proportionality between data delivered

by SME’s and large caps . This risks to put a strain on the resources of SME’s .


9 . More clarity is needed on the requirements for precontractual disclosure . In particular, the following is-

sues should be addressed .

a . A clear demarcation of which products fall under SFDR art 8 and art 9 respectively;

b . The relation between the information to be provided at the level of the financial institution

and at the level of products .

10 . The 32 mandatory indicators reflect to a large extent the status of the political decision making in Europe,

with a focus on the E(nvironmental), where the Taxonomy Regulation reflects a political consensus . This

results in a choice of 16 mandatory Environmental indicators . G(overnance) on the other hand has no

‘own’ indicators, neither mandatory, nor optional . Instead, the indicators relevant for Governance are

inserted into the indicators for “Social and Employee Matters”, leaving less potential indicators for the

latter . Unfortunately, the ESA’s are constrained here by the level 1 legislation, which does not give them

a mandate to elaborate separate draft regulatory standards on G(overnance) . The focus on the E reflects

the European context while other countries/regions may focus more on S(ocial)1 and G(overnance) . The

focus on the E should not obscure the importance of the S and G . This is all the more important as the

indicators that are distinguished by the SFDR will probably guide the review of the NFRD .

II . The timing: putting the pieces of the puzzles together…

Alignment with other legislation

11 . The draft RTS and the SFDR in its entirety cannot be seen in isolation but are part of a puzzle, the pieces

of a which will gradually be assembled over the next two-three years .

12 . Of direct relevance to this draft RTS are:

a . MiFID II Commission Delegated Regulation: the draft text aligns the reporting on principal

adverse impact with the timing for precontractual disclosure in SDFR, i . e . 30 December

20222 . When it comes to retail clients the alignment with regard to MiFID II (and PRIIPs) is

highly desirable . The scope of the financial products defined in article 2(12) SFDR however

is not consistent with the scope defined by the draft text of MiFID II (Art . 1 Delegated Di- rective 2017/593) and Art . 2 (Delegated Regulation 2017/565) . This may cause problems

when it comes to financial instruments others than those defined in the SFDR which are

designed to respond to investors sustainability preferences and where the issuer is required

to comply with MiFID II product governance requirements . Therefor we recommend that

the ESAs should already take into account the necessity of making the scopes consistent .

b . Taxonomy Regulation3: the Taxonomy Regulation contains several links to SFDR .

i . Art 18: linking ‘minimum safeguards’ and ‘do not significantly harm’: unfortunately,

due to the difference in timing between the approval of the Taxonomy Regulation

and the draft RTS, not all of the ‘minimum safeguards’ provided for in art 18 of the

Taxonomy Regulation are in Annex 1 of the draft RTS4

1 For example, the focus on diversity in the American context .

2 … . as of 30 December 2022, considers principal adverse impacts on sustainability factors, as referred to in article 7(1), point (a), of

that Regulation .

3 Regulation 2019/2088, in full: Regulation on the establishment of a framework to facilitate sustainable investment and amending

Regulation 2019/2088 . It is popularly known as ‘Taxonomy Regulation’ .

4 The OECD Principles for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights are not in Annex

1 of the draft RTS, neither as mandatory nor as opt-in indicators .


ii .

follow-up tasks for the ESA’s to provide draft RTS on environmental objectives, with

as deadlines (depending on the kind of objective) 1 June 2021 and 1 June 2022;

iii . More granular timings, at least as far as it touches upon environmental objectives .

For all of the above, the Taxonomy Regulation incorporates amendments to the SFDR .

Apart from these, the Taxonomy Regulation also provides a timetable for its own extension .

By 31 December 2021 the Commission shall publish a report to extend the scope of the

Taxonomy Regulation to cover other sustainability objectives, such as social objectives

(Taxonomy Regulation, art . 26 (2)) .

The SMSG suggests to reinforce the link between the Taxonomy Regulation and the Sus- tainable Finance Disclosure Regulation in particular regarding the definitions of sustainable

investment .

c . Non-Financial Reporting Directive: a review of the NFRD is scheduled . The Commission

proposal is scheduled in Q1 2021 . The relevance of the NFRD is discussed below .

d .

the review of UCITS and AIFMD . This refers to elements such as the organization of the

firm and the assessment of sustainability risk, that are outside the scope of the draft RTS .

The SMSG understands that the draft RTS are constrained by Level 1 legislation . Never- theless, we suggest that the templates are developed as part of the existing funds’ docu- mentation, rather than as new documents . However, the provisions should be practically

thought-through and well- aligned with other key client disclosures, such as the UCITS KIID

and its space constraints . More generally, for information requested in templates for pre- contractual disclosures, more guidance would be useful with respect to whether and to what

extent references (links) to websites containing the required information will be accepted .

Stepwise approach for SFDR itself

13 . The SFDR itself provides for a phased implementation:

a . By 30 December 2020, the ESA’s shall develop draft RTS in relation to the adverse impact

on the climate and the environment and on precontractual disclosure requirements for art

8 and 9 products . By 30 December 2021, they shall develop draft RTS in relation to adverse

impacts in the fields of social and employee matters, respect for human rights, anti-corrup- tion and anti-bribery .

b . The first full period for the reporting (website) at the level of the entity (=financial institution)

is 31 Dec 2021 – 31 December 2022 .

c . By 30 December 2022, precontractual disclosure at product level should be ready .

d . By 30 December 2022, the Commission shall evaluate the SFDR, considering in particular

proportionality and data availability .

Timing constraints for the draft RTS

14 . In referring to policy options for the Do Not Significantly Harm principle, the ESA’s themselves indicate

that they were “not able to consider all policy options’ possible detailed impacts due to the general lack

of time to develop the proposals” (draft RTS, page 91) . The SMSG is aware of the timings set by the

Level 1 legislation . However, taking into account on the hand the importance of this legislation, on the

other hand the timing constraints under which the draft RTS need to be developed, it prefers a stepwise

approach, that allows for gradual improvement, over a Big Bang at an early stage .


Towards an iterative process

15 . From the overview above, the SMSG concludes that there will be a complex interaction between different

pieces of legislation for at least two years to come . The amendment of the SFDR by the Taxonomy

Regulation is a first proof of this . Taking into account the iterative interaction between different pieces

of legislation that will follow in the next two years, the SMSG contests the usefulness of a Big Bang with

regard to data provision at an early stage .

16 . Apart from the considerations above, there is a particular legal concern . The draft RTS to be provided

by the ESA’s are input for the Commission to supplement the Regulation . Taking into account the time

allowed to the Commission to endorse the draft RTS proposed by the ESA’s and the time allowed to

Parliament and the Council to object to the RTS, it is theoretically impossible to have the RTS endorsed

by the start date of the SFDR, i . e . 10 March 2020 .

17 . The SMSG recognizes the virtues of different points of view with regard to the start of the SFDR and in

particular the draft RTS . On the one hand, it is important to move forward . On the other hand, the

problems with regard to data availability cannot be disregarded .

18 . The draft RTS are multifaceted . They include elements such as the use of templates for comparability

and simplicity, the description of policy principles, engagement policies and, also, as one element

amongst other, the use of 32 mandatory reference indicators and a series of optional indicators .

19 . It is on these reference indicators that much of the discussion is focused . The prime merit of suggesting

indicators at this early stage is that they provide input for review of the NFRD (see below, discussion on

the Non-Financial Reporting Directive) . On the other hand, the obligation to describe 32 indicators and

a series of optional indicators creates, for the entity, a problem of data availability and or the end investor

a problem of information overload . Also, these indicators refer primarily to the entity level, less at product

level . For this reason, the SMSG is fearful of a Big Bang, which puts much of the challenge for data

provision at an early stage and at level which is less relevant (entity level) .

III . The Non-Financial Reporting Directive

20 . Although NFRD is not the topic of this consultation, there are good reasons to discuss the relation to


21 . On the one hand, the NFRD can facilitate the availability of data . However, realistically speaking there

will be a substantial time gap between the implementation of the SFDR and the review of the NFRD .

The Commission proposal for the NFRD is not expected before Q1 2021 . At that time, the trilateral

interaction between Parliament, the Commission and the Council still has to start . In the absence of the

reviewed NFRD, the dependence on a limited number of dataproviders increases .

22 . On the other hand, by suggesting indicators, irrespective of whether they are optional or mandatory, the

SFDR and its technical guidelines, provide input for the review of the NFRD . This means that the choice

of indicators should be carefully balanced:

a .

b .

the longer the list of mandatory indicators, the less scope there will be for the NFRD to

differentiate for example between companies > 500 employees and SME . A degree of

proportionality in the NFRD would be useful to avoid too high a reporting burden for SME’s

and to avoid perverse side-effects like encouraging a shift to private equity, away from listed

entities .

the present lack of standards for data delivery often results in additional work for issuers as

they have to fill in different questionnaires by different interested parties . In this respect,

bringing more standardization through a reviewed NFRD could be beneficial . However, to

the extent that there is a relative underweight of S and G in the indicators proposed by the

SFDR, there is a risk that this is mirrored in the NFRD as well . Apart from the ethical and


social considerations, this could negatively impact the relevance of the NFRD and its po- tential to become an alternative for the multiple questionnaires .

23 . For all these reasons, the SMSG believes that an iterative process of cross-fertilisation between the

SFDR and the NFRD is useful . The draft regulatory standards can facilitate this by allowing a phased

approach .

24 . One of the concerns of the SMSG is reliability of data . However, the end result (i . e . the disclosure

pursuant to the SFDR) depends on the reliability of the input . For this reason, the SMSG calls on legis- lators to provide sufficient safeguards that the data provided through the NFRD are reliable .

25 . Possible remedies in the remits of the ESAs mandate (especially relevant to product disclosures) are the


a . Ensure flexibility (and legal certainty) by allowing the use of qualitative information, narrative

descriptions and estimates . However, some members are concerned that narrative de- scriptions and estimates may be used to deprive readers from the relevant information or

may be misleading . Also, estimates are impractical for several indicators (for example gen- der diversity at the board) . An alternative suggestion, with pros and cons, is to make the

reporting on a specific part of the investment universe on a best effort base rather than

using estimates;

b . Carefully balance information to be provided in pre-contractual disclosures vs website dis- closures . Website disclosures are better suited to disclose information characterized by

uncertainty and frequent updates . Those could be more easily updated, subject to availa- bility of data .

IV .

32 mandatory indicators + optional indicators for adverse impact

Article 4: an intro for dummies

26 . The ESA’s have a mandate, under article 4(6) and 4(7) of the SFDR to develop draft regulatory technical

standards in relation to adverse impact:

a . climate and other environmental-related adverse impacts; (art 4 . 6, by 30 December 2020);

b . social and employee matters, respect for human rights, anti-corruption and anti-bribery mat-

ters (art 4 . 7, by 30 December 2021) .

27 . The SMSG notes and regrets that this does not specifically include governance indicators .

28 . It is important to keep in mind that article 4 refers to transparency on adverse impacts at entity level (i . e .

at the level of the financial institution, not at product level) .

29 . To do so, the draft RTS propose a format (template) that includes:

a .

a summary;

b . a description of principal adverse impacts;

c .

description of policies to identify and prioritise principal adverse sustainability impacts;

d .

description of actions to address principal adverse sustainability impacts;

e . engagement policies;


f .

references to international standards .

30 . The SMSG acknowledges the usefulness, for reasons of simplicity and comparability, of a format to

disclose policies, actions and engagement .

31 . However, the approach chosen for the description of adverse impact is strongly contested .

Adverse impact indicators: what the fuss is all about

32 . The ESA’s propose 32 mandatory indicators (Annex 1), to be complemented by some optional indicators .

Of the 32 mandatory indicators, 16 refer to E(nvironmental) indicators, that are to a large extent mapped

on the Taxonomy Regulation . Theoretically, the aggregation of all these reference indicators at entity

level could reflect some kind of name and shame approach, with as aim identifying financial institutions

that offer products with proportionally higher adverse impacts . Although this would probably present

data overload for the average retail investor, it may be relevant for other parties (for example: journalists;

stakeholder representatives; organized shareholders) . Nevertheless, this approach runs into a variety

of practical problems:

a . Certainly in the first years, there will be data problems: (“bad data drive out the good ones”) .

At a product level, some products will at an earlier stage have reliable quantified data while

others may lag (for example large cap funds vs SME funds) . However, aggregation over

all products would mean that reliable data are lumped with incomplete data;

b . A complete class of products is outside the scope of the draft RTS anyway: government

bond funds . Annex 1 of the draft Regulatory Technical Standards does not include a single

indicator relevant to government bond funds . Aggregating over products is not relevant if

a major class of products is excluded .

c .

the set of potential indicators, either mandatory or potential, may not yet be optimally bal- anced nor complete . Progressive insight or the iteration between SFDR, the NFRD and the

Taxonomy Regulation or other pieces of regulation could result in additional finetuning .

However, the present proposal of 32 mandatory indicators risks of setting in motion a huge

investment into data provision, so that there is little scope for finetuning afterwards . A Big

Bang risks to introduce path dependency which excludes finetuning at a later stage . Some

examples where finetuning could be useful:

i .

item 6 (annex 1): “breakdown of energy consumption by type of non-renewable

source or energy” . Proposed indicators should be aligned as much as possible

with requirements by other reporting standards . However, the proposed indicators

require more detailed information than what is currently disclosed by the CDP;

ii . “Excessive CEO pay ratio” could possibly be better aligned with the disclosure ob- ligation required under the Shareholders Rights Directive II, which does not require

a ratio per se but a comparison between the evolution of the performance of the

company, the evolution of the remuneration of directors and of those of the employ- ees of the company (see art 9b (1b) in addition to a narrative to be provided under

article 9a (6) how pay and employment conditions were taken into account in the

remuneration policy .

iii .

item 26 and 27, annex 1: these indicators express the risk that a company is ex- posed, in terms of the type of its operations or its geographic areas, either directly

or through its suppliers to the risks of compulsory labour or child labour . However,

these regions do need more, not less investment – be it that is ethical investment .

On the other hand, ‘supplier code of conduct’, which would be relevant in this case,


is just an optional indicator (table 3, item 3) . More in general, it would be useful to

have a closer look at potential Global Value Chain indicators;

iv . not all of the minimum safeguards of Article 18 of the Taxonomy Regulation are in

Annex 1 of the draft RTS .

v . Several of the indicators proposed in Annex 1 require instructions on how to calcu- late them . Example: gender pay gap (proposed indicator 18) . One can use differ- ent definitions of employee (only persons with work employment contract; persons

employed on civil-law contracts; temporary workers; insourced employees; etc . ) .

Also, one may calculate base salary (gross or net), base salary+bonuses etc . Clar- ification is needed to allow comparability . Alignment with the Shareholder Rights

Directive should be investigated .

33 . The quantitative data on itself only tell part of the story and it must be avoided that they start leading a

life on their own . For example, engagement/(proxy) voting is very relevant and could be used as a lever

to encourage change, for example if one has a high exposure to fossil fuel companies .

34 . The choice to describe adverse impact through a combination of mandatory and optional reference indi- cators is primarily a choice made by the ESA’s to ensure comparability and discussed with pro’s and

con’s in the draft RTS (see p 72 – 73), rather than a formal legal obligation resulting from the level 1

text .

35 . Article 4 refers to disclosure at entity level . The SMSG is of the opinion that the product level is the most

relevant for the following reasons:

a . The investors buys a product (an investment fund; a pension fund…), not the managing

asset manager .

b . Consistency with other pieces of legislation, in particular MiFID . MiFID will be reviewed to

incorporate sustainability preference in suitability assessment and in product governance .

However, this is at product level .

c . Alignment with the responsibility of the financial advisor . The draft RTS, article 12, de- scribes the responsibility of the financial advisor with regard to adverse impact . This too

refers to the product level: “The statement shall contain details on the process to select the

financial products they advise on, including the following: (a) how the information published

by financial market participants in accordance with this Regulation is used; (b) whether the

financial adviser ranks and selects financial products based on the principal adverse im- pacts referred to in Table 1 of Annex I and, if so, a description of the ranking and selection

methodology used; and (c) any criteria or thresholds used to select financial products and

advise on them based on those impacts . ”

From entity level to product level

36 . While all of the above contests (i) the mandatory aggregation of reference indicators at entity level, (ii)

the high number of these mandatory indicators, it does not contest the usefulness of indicators as such .

However, the usefulness stems from other reasons:

a . As a common toolbox for cross-sector non-financial analysis . This toolbox should also be

viewed a common language between investors/analysts on one side and issuers on the

other . The dialogue with issuers is paramount to reach meaningful transparency .

b . As input for the review of the NFRD


c . As input for the disclosure at product level, to ensure, that where reference indicators are

used, these follow common methodologies . Although article 4 refers to disclosure at entity

level, there is also a link to information at product level .

i . Article 7, referring to transparency of adverse sustainability impacts in precontrac- tual information at product level: “Where information in Article 11(2) includes quan- tifications of principal adverse impacts on sustainability factors, that information

may rely on the provisions of the regulatory technical standards adopted pursuant

to Article 4(6) and (7)” .

ii . Draft RTS, article 16, referring to precontractual information for products promoting

amongst others environmental of social characteristics (i . e . art 8 products): “Where

a financial product invests in a sustainable investment, the section shall also con- tain an explanation of how the sustainable investment does not significantly harm

the sustainable investment objectives, including: (a) how the indicators for adverse

impacts in Annex I are taken into account; and… .

iii . Draft RTS, article 25, referring to precontractual information for products having

sustainable investment as their goal (i . e . art 9 products): promoting amongst others

environmental of social characteristics (i . e . art 8 products): “The section referred to

(…)shall contain an explanation of how the investments of the financial product do

not significantly harm the sustainable investment objectives, including: (a) how the

indicators for adverse impacts in Annex I are taken into account; and…

iv . Draft RTS, article 34, referring to website product information for article 8 products:

“…Where a financial product invests in a sustainable investment, the section shall

also contain an explanation of how the sustainable investment does not significantly

harm the sustainable investment objectives, including: (a) how the indicators for

adverse impacts in Annex I are taken into account; and…” . A similar reference to

Annex 1 is made for periodic reports of article 8 products (draft RTS, article 38)

v . Draft RTS, article 35, referring to website product information for article 9 products:

“The section… . shall contain an explanation of how the investments of the financial

product do not significantly harm the sustainable investment objectives, including:

(a) how the indicators for adverse impacts in Annex I are taken into account;

and…” . A similar reference to Annex 1 is made for periodic reports of article 9

products (draft RTS, article 39) .

37 . The references to Annex 1 show the importance of Annex 1 as a framework containing standardized

reference indicators . On the other hand, it is not clear to what the wording “may rely on” (art 7); “shall

contain an explanation how the indicators referred to are taken into account” (art 8 and 9 products)

exactly implies . While the SMSG is aware that the ESA’s do not have a mandate on article 7, they do

have a mandate to elaborate RTS for article 8 and 9 products .

38 . For all these reasons, the SMSG believes that is extremely important to carefully balance the information

to be presented at product level:

a . Clarity is to be given on the relation between reference indicators at entity level and those

at product level .

b . A degree of flexibility should be safeguarded to finetune the choice of reference indicators

to the nature of the product, without increasing the information overload . The relevance of

reference indicators depends partly on the nature of the product . For example: a reference

to the OECD guidelines for MNC’s may be useful for a large cap equity fund, but much less


for a SME fund . However, an extended set of mandatory indicators plus opt-in indicators,

leaves little possibility to add optional indicators without increasing the data overload .

c . Notwithstanding this degree of flexibility, circumvention should be avoided . To avoid cir- cumvention, it is important that it is disclosed why particular indicators are used and why

others are not . Also, where reference indicators are used, they should be standardized .

39 . As a possible way out within the confines of the level 1, the SMSG would suggest:

a .

rather than 32 mandatory indicators and additional opt-in indicators (entity level), a strongly

reduced core-set of indicators to be used whenever relevant following a strict comply or

explain mode5, that could possibly expand over time, as data availability improves . While

the SMSG acknowledged the difficulties arising at this point in time, some insisted that the

goal should remain for these indicators to become mandatory after a given period in time,

with the scheduled review of the SFDR by 30/12/2022 as possible target date . Starting with

a limited core set of indicators would have the advantage of reducing the workload at a time

when there are still many uncertainties; reducing the risk of path dependence; not confining

the information to be given at product level . Although the SMSG advances the principle of

a core set of indicators, it was not able, due to timing constraints to evaluate examples of

such core sets . In any case, they should aim to be cross-sectoral, have high propensity to

standardization and data availability . In this case, a high degree of compliance can be ex- pected .

b . Use the field “description of policies to identify and prioritize principal adverse sustainability

impacts” in the template to be developed under article 4, to disclose which criteria are used

to select and prioritize indicators for adverse impact at product level and the process (gov- ernance) through which this done .

c . Use the templates (still to be developed) for art 8 and 9 products, on which the ESA’s have

a mandate, to disclose why particular indicators were used and why others were not .

V . Disclosure at the level of products

40 . The ESA’s have a mandate to develop draft RTS for disclosure at product level for article 8 and article 9

products . This refers to precontractual information (SFDR article 8-9); website information (SFDR article

10) and periodic reports (art 11) .

Art 8 and 9: what are we speaking about?

41 . A particular concern of the SMSG is that there is still much confusion about what exactly is meant by

article 8 and article 9 products . The SMSG calls on the ESA’s (together with the Commission) to provide

further clarification to that extent . That should preferably be done through the draft RTS, to the extent

that the ESA’s have a mandate to do so through the draft RTS; if not so, through, for example, Q&A;

42 . While art 8 in particular invokes uncertainty and confusion, there are also uncertainties surrounding arti- cle 9 products . The Level 1 legislation (SFDR, article 9), refers to article 9 as: “where a financial product

has sustainable investment as objective” . The draft RTS refers to “sustainable investment objective of

the product”, and also to “the” sustainable investment objective . We would suggest to align the wording

with the level 1 text (i . e . sustainable investment as objective) .

5 While a majority of the working group members agreed with the wording, there was no full consensus on the reference to a comply

or explain mode . The intention was to avoid, by using the word ‘mandatory’ a wording that leaves no room to exceptions and opera- tional real-life challenges . Against this concern stood the fear that comply or explain should not result in dilution .


Art 8: how to make sure that the investor knows what he is buying

43 . The SMSG is concerned that, given the wide range of products that could possibly fit under article 8, it

is important that there is sufficient disclosure on the degree of sustainability within an article 8 product .

For this reason, a graphic representation, as provided for in the draft RTS (article 15), is potentially

helpful, although it requires a taxonomy on social objectives to be fully effective . In addition, the accom- panying narrative needs to be sufficiently simple and straightforward . Also it is important that there is

consistency between marketing communication and website information/ precontractual disclosure de- scribing the degree of sustainability of article 8 products, which the ESA’s can safeguard in terms of

SFDR article 13 .

44 . Related to this, The SMSG discussed the warning to be provided in precontractual disclosure for article

8 products (draft RTS, article 16, 1: ‘this product does not have as its objective sustainable investment’) .

In considering this warning, the SMSG took into account the following considerations:

a .

it is important to distinguish article 8 from article 9 products, the latter having sustainable

investment as objective (while article 8 products promote, amongst others, environmental

or social characteristics);

b .

the wording of this warning is such that it could result in investors disregarding this product

from a sustainability pointy of view;

c .

this warning comes on top of a warning to be provided because of the Taxonomy Regula- tion6 and on top of a narrative accompanying a graph that illustrates the degree of sustain- ability, making disclosure extremely complex to understand .

45 . As an alternative to the warning proposed in draft RTS art 16-1, the SMSG proposes to use the narrative

accompanying the graph, for example through wording like: “only the part indicated in the graph … pro- motes environmental or social characteristics” .

Adverse impact at the product level

46 . Finally, the SMSG discussed the disclosure requirements for adverse impact at product level (art 8 and

9) . Neither the level 1 text, nor the draft RTS explicitly contains the provision that the indicators in Annex

1 are to be described or quantified at product level . The draft RTS requires: “Where a financial product

invests in a sustainable investment, the section shall also contain an explanation of how the sustainable

investment does not significantly harm the sustainable investment objectives, including: (a) how the in- dicators for adverse impacts in Annex I are taken into account . “ However, this wording does not consti- tute an obligation to describe in full these indicators .

47 . With regard to product level, the SMSG confirmed the relevance of different issues mentioned before .

a . A timing problem: it will take substantial time before it will be possible to quantify these

indicators, due to lack of data . Nevertheless, the SMSG also recognized that the indication

that certain indicators will need to be used, can trigger the provision of these data, be it with

a delay;

b . The relevance of indicators differs depending on the product;

6 Taxonomy Regulation art 6: ‘The “do no significant harm” principle applies only to those investments underlying the financial prod- uct that take into account the EU criteria for environmentally sustainable economic activities . The investments underlying the remain- ing portion of this financial product do not take into account the EU criteria for environmentally sustainable economic activities . ’


c . There is a need for finetuning of indicators as well as for an iterative process between dif- ferent pieces of legislation rather than a Big Bang which seals the indicators that are to be

used .

d . The complexity of the data to be disclosed is a cause of concern:

i .

for the investor . In addition to the risk of information overload, the definitions of

article 8 and 9 products; concepts such as adverse impact, the relation with the

Taxonomy Regulation, … . It all adds up to an increasingly complex puzzle . Con- sumer testing of templates and the provided information would be useful, but apart

from that draft RTS should avoid needless complexity through information over- load . Yet on the other hand, the SMSG is aware that for specific stakeholders

(consumer representatives; NGO’s; journalists…) this information, although com- plex, is potentially relevant;

ii .

for asset managers . A specific concern is that the data requirements could be so

demanding that they become barriers to entry for smaller financial entities . In such

a case, that could have as adverse side-effect that less, not more investment is

channelled to sustainable finance .

e .

It must be avoided that these quantitative indicators start living a life on their own .

48 . With this in mind, the SMSG considered an approach, derived from the draft RTS, where for each prod- uct, all of the 50 Annex 1 impact indicators should be assessed . This approach would be the most

comprehensive one and is related7 to option 1 . 3 in the draft RTS on Do Not Significantly Harm (page

89) . The most comprehensive approach was considered to avoid that at product level, the indicators

were confined to the selection of opt-in indicators selected at entity level . Note that on itself, this would

not require financial market participants to publish details of the product’s impact against the indicators,

but only to disclose how it has taken into account the indicators . Under the ESA’s favoured option (see

option 1 . 2, page 90), assessment would require that it is assessed whether the investments made by the

product do not significantly breach certain thresholds, defined by the financial market participant, for any

of the indicators .

49 . However, the SMSG concluded that this was not in line with its concerns . First of all and foremost, it will

be impossible for a substantial time to implement it . Secondly, it does not distinguish between indicators

that are relevant for a specific product and those that are not . Thirdly, the use of thresholds sets quanti- tative exclusion criteria and in doing so does not allow for qualitative considerations to be taken into

account . Finally, it would require a heavy exercise, while the SMSG preferred a gradual process whereby

through an iterative process the methodology is improved over time .

50 . The SMSG also touched upon two subsequent alternatives .

51 . The first one is ‘out of the box’, as compared to the paradigm of the draft RTS (i . e . use of extended set

of adverse impact indicators . It consists in considering a limited and evolving list of indicators (Environ- ment, Social, and Governance) used like a common toolbox for investors/analysts . These indicators

should be of potential, but varying relevance in different sectors . Whenever relevant, these indicators

should be used to evidence the fund’s Principal Adverse Impact . These indicators should also be

con- tributed/approved by the issuers to ensure meaningfulness as well as cross-sector data availability . An- other advantage would be that it results in a limited number of indicators, tailored to the product .

52 . For the other alternative, the starting point would be the complete set of Annex 1 indicators . However,

not assessing indicators would be possible on a “comply or explain” basis for three possible reasons: (i)

the indicator is not relevant for the particular product; (ii) due to lack of data, the indicator cannot yet be

7 Not identical, because option 1 . 3 also captures the Taxonomy Regulation’s Environmental objectives .


used; (iii) the financial market participant has another indicator for the same issue8 . Possibly, this

“comply or explain” approach could be integrated in the template (still to be developed) for reporting on

art 8 or 9 products, in the field that allows to explain why and how certain indicators are prioritised .

Certainly, in the beginning, with a scarcity of data, “comply or explain” should be allowed to be the rule

rather than the exception . Once a reduced number of indicators is selected, it should be indicated how

investments are assessed against these indicators . Thresholds are but one of several possibilities to do

so . For example: the exposure to high risk areas regarding compulsory labour/child labour could be

mitigated through alignment with OECD guidelines for MNC’s, ILO recognized Global Framework Agree- ments, suppliers Codes of Conduct or else . Or exposure to fossil fuel companies could be mitigated by

engagement policies (voting) . Rather than referring to thresholds as only alternative, the draft RTS

could refer to different possible alternatives . Compared to the first alternative (the ‘toolbox’), this second

alternative would alleviate some of the problems associated with the use of the Annex 1 indicators .

However, the starting point, with pros and cons, would still be the extended set of indicators .

53 . Due to time constraints, the SMSG could not discuss the proposals at length, nor achieve consensus .

They are mentioned as illustration of possible alternatives, with a call to the ESA’s to investigate these

and other possible alternatives before coming to a final proposal, keeping in mind the concerns raised

by the SMSG .

VI . Financial impact of the proposals

54 . The draft RTS attempt to quantify the financial impact of the proposal (see page 74) . In doing so it refers

to the impact assessment done by the Commission, where the focus is on the cost to buy external data,

doing internal research, engagement policies…) . The overall conclusion is that this cost is marginal .

55 . The SMSG is concerned that this impact analysis focuses only at one cost element: the purchase of data

and the use of it by the financial entity . In addition, the SMSG believes that two more cost elements

need to be taken into account .

56 . At the level of distributor, there is the additional costs of financial advice – at least in a context where

advice is given person-to- person . Assuming a gross wage cost of a financial advisor equivalent to 1

euro/minute (proxy) and assuming that explaining these indicators would require an additional 10 – 15

minutes, the additional wage cost of advice would be equivalent to 10 – 15 euro . On an investment

amount of 5000 euro, this would be equivalent to a one-off cost of 0 . 2 to 0 . 3% . Simplicity and avoidance

of data overload could be useful here . Data overload would not only be more time consuming for the

advisor, but would neither be desirable from the investor’s point of view .

57 . Secondly, there is the cost of data delivery, i . e . costs for issuers . These costs may be proportionally

higher for SME’s . Also, in comparison to large corporations, they often do not yet have processes in

places to provide such data . However, there also possibilities to lessen this cost . At present, issuers

are asked by different agencies to provide sustainability data . To the extent that standardization could

result in less data varieties to be provided and less different formats to be filled in, it would contribute to

lowering the costs of data provision . However, to achieve this goal, a well-balanced iterative process

between at least three crucial pieces of legislation is needed: the Taxonomy Regulation; the Non-Re- porting Directive and the Sustainable Finance Disclosure Regulation . However, the SMSG believes that

at present, the situation is still premature . Hence, it is important that the draft RTS does not constrain

the iterative process .

VII . Other issues

8 This third option could reduce comparability among products and financial market participants . On the other hand, it is in line with

the concern to allow an iterative process of improving the indicators, as it could allow learning by doing by suggesting alternative and

possibly better indicators for the same issue .


58 . For financial products that are “portfolios” ESAs note in the consultation paper (see page 12) that the

requirements on product-by-product disclosures on websites will entail GDPR considerations . The

SMSG notes that in addition thereto, it should be considered whether a requirement to disclose infor- mation linked to individual clients could in fact be in contravention with bank and contractual secrecy

legislation and which regulatory measures could be taken to remedy this problem .

59 . The SMSG also suggests to consider the specific situation of green bonds (or rather a fund investing

into green bonds), where the issuer has possibly set in place due diligence to separate the funding for

the project from general corporate funding . To what extent are the present disclosure requirements and

in particular the descriptive indicators meaningful for these products?

60 . While templates could be useful for retail investors, the SMSG suggest to look at other ways of disclosure

for institutional investors . Institutional investors may face very specific disclosure requirements, that

could probably not be met through standardized templates .

61 . It is possible that financial market participants or products consider other adverse impact than the one

mentioned in Annex 1 . Examples: exclusion criteria for adult entertainment, tobacco… To avoid later

discussions with regulators, it would be good that the draft RTS explicitly allows financial market partici- pants and products to include additional adverse impact indicators .

62 . the public utility of having the Commission to organize a consolidated database where issuers report and

different stakeholders access quality ESG data should be assessed .

This advice will be published on the Securities and Markets Stakeholder Group section of ESMA’s website .

Adopted on 14 September 2020


Veerle Colaert

Chair, Securities and Markets Stakeholder Group


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