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Freshfields Sustainability

| 6 minutes read

Navigating Sustainable Finance: ESAs' 2023 Findings on PAI Disclosures

In their second annual report on the extent of voluntary disclosure of Principal Adverse Impacts (PAIs) under the EU Sustainable Finance Disclosure Regulation (SFDR) dated 28 September 2023, the Joint Committee of the three European Supervisory Authorities (EBA, EIOPA and ESMA – the ESAs) unveil insightful findings on the current state of PAI disclosures. The report stems from a meticulous survey among National Competent Authorities (NCAs) and offers a deep dive into good and bad practices of PAI disclosures, accompanied by key recommendations to the European Commission and the NCAs. The report is based on Art. 18 SFDR, mandating the ESAs with an annual review of the extent of voluntary PAI disclosures.

In this blogpost, we analyse the key findings of the report against the regulatory background and provide examples of the observed good and bad practices. Further, we shed light on some of the remaining challenges regarding data and product-level disclosures and provide an outlook on developments to consider in the future.

Regulatory background and current state of regulation

PAI pertains to negative impacts of investment decisions of Financial Market Participants (FMPs) on certain sustainability factors that shall be disclosed under the SFDR either at entity or product level. The entity-level disclosure requirement stipulated in Art. 4 SFDR mandates FMPs to publish on their website annual PAI statements which include disclosures on their due diligence policies with respect to PAI. While only FMPs employing more than 500 employees are obligated to comply with the entity-level disclosure requirement, smaller asset managers and financial advisers may be affected as well if they engage with larger FMPs that request data to include in their mandatory PAI statements.

PAI disclosures under Art. 7 SFDR at the level of the financial product are, by contrast, voluntary, as confirmed by the ESAs in their report. They require both a description of whether and how the FMP considers PAI for the relevant financial product in the pre-contractual disclosure documents, and a retrospective description of how it has considered PAI for the last financial year in the annual or periodic report of that product.

The application of PAI considerations at entity-level and the associated disclosure requirements is further detailed in the SFDR Delegated Regulation, in particular its Annex I, which became effective from January 1, 2023. The SFDR Delegated Regulation is already being revised by now including in respect of the PAI disclosures and Annex I. Most notably, new PAI social indicators may be introduced and calculation formulas for PAI indicators shall be revised and harmonized.     

Key findings

The survey of the NCAs aimed at achieving two primary objectives: first, to collect feedback on entity-level voluntary PAI disclosures, and second, to gain insights into why certain FMPs opted to not consider adverse impacts of investment decisions on sustainability factors. In addition, the survey for the first time covered disclosures of PAI consideration at product-level since Art. 7 SFDR applied only by December 30, 2022. The following are the key findings:

  1. Overall Enhanced Compliance: Survey results reveal a noteworthy improvement in the application of voluntary PAI disclosures. This marks a significant stride towards aligning financial products with sustainability goals. Disclosures have become more accessible and user-friendly on websites, promoting greater transparency.
  2. Significant variation: The extent of compliance with disclosure requirements varies significantly and, in particular, disclosure of due diligence policies remains “extremely” limited.
  3. Unclear Explanations: The clarity of explanations for non-consideration of PAI requires improvement. Many FMPs' explanations still lack completeness and satisfactory details. 
  4. Ambiguous Paris-Alignment Disclosures: Disclosures concerning the degree of alignment with the Paris Agreement remain vaguely formulated. The ESAs consider it essential to achieve clearer and more precise disclosures to provide investors with the necessary information for informed decisions.
  5. Limited product-level disclosures: Voluntary disclosures of PAI consideration for financial products require further analysis in future as the level of understanding of such disclosures is limited.

Good and bad practices

The report includes a set of good and bad practices, most of which are linked to the key findings of the report set out above. Supervisory authorities are increasingly relying on such means of communication to document their rising expectations for the implementation of new regulations in the context of ESG (see also our blogpost in the context of C&E risks). 

As a general recommendation, specifically highlighted by the ESAs, FMPs shall clearly identify the relevant disclosures on their website, making the information easily accessible, clear and intuitive for all types of investors to find.

In terms of entity-level disclosure, the ESAs point out that FMPs shall issue clear statements which describe the FMPs’ strategies for identifying and weighting the relevant PAI indicators, the methodology and data used for the assessment of each PAI, and the reference period of the statement. Where applicable, PAI statements shall also include a brief summary of the engagement policies and adherence to responsible business conduct codes and internationally recognised standards. 

Bad practices include, for example, FMPs failing to provide reasons for the non-consideration of PAI, as they mistakenly assume that employing fewer than 500 employees is a sufficient explanation.

In terms of product-level disclosures, good practices include, for example, FMPs indicating when additional information regarding PAI consideration will be made available. Some FMPs stated that they would reserve the publication of further information on PAI consideration for their first PAI statement at entity-level, due on June 30, 2023. This proactive approach is considered a positive practice and doesn't prejudice the FMPs ability to present reasons for not considering PAI on sustainability factors, as outlined in Article 7(2) of the SFDR.

On the other hand, the ESAs consider it as a concerning practice that FMPs confuse Art. 7(1) SFDR and Art. 7 of the Taxonomy Regulation.

Interestingly enough, the ESAs don’t appreciate references to a possible lack of legal clarity and unclear procedure to calculate PAI on sustainability indicators. In the ESAs’ view, they have provided numerous clarifications and responses to stakeholders’ queries to provide clarity to the market. Other FMPs would have managed to calculate PAIs as well, the ESAs note. That is notable as the PAI statements published in June this year reveal different approaches as regards both the calculation formula of PAI indicators and the level of detail regarding qualitative descriptions. It can be assumed that some market participants will have to make considerable adjustments to their entity-level PAI statements in order to meet the supervisory authorities’ expectations for the 2024 PAI statements.


Remaining data challenges

A significant challenge relates to the quantitative dimension included in the central component of PAI statements, the table set out in Annex I of the SFDR Delegated Regulation. In this table, companies must list their (quantitative) impact on 14 core PAI indicators, e.g. tons of greenhouse gas emissions or emissions to water allocated to their investment in investee companies, and 2 additional indicators.  

In this respect, the availability and quality of data continues to be a major issue. While some data points, such as greenhouse gas emissions, are readily available, indicators related to other ESG aspects pose significant challenges in terms of data availability (e.g. the unadjusted gender pay gap and hazardous and radioactive waste ratio of investee companies).

Overall, the data landscape is expected to improve with the implementation of the EU Corporate Sustainability Reporting Directive (CSRD, see our client briefing), which will enhance both the availability and quality of sustainability-related data for all stakeholders involved in sustainable finance. Meanwhile, FMPs are expected to make their "best effort" to obtain the necessary information. PAI statements often rely on purchased data from ESG-rating providers. However, ESG-rating providers have long been criticised for using different methodologies, leading to significant variations in results and in the European Commission's recent regulatory proposal, the provision of raw data was explicitly excluded (see our blogpost).

Remaining gaps in product-level disclosures 

Another challenge is the limited comprehension of voluntary disclosures of PAI consideration at product-level under Art. 7 SFDR. Some FMPs have been observed confusing this with other regulations, such as the Taxonomy Regulation.

This highlights the need for further clarity in product-level disclosures to ensure effective implementation and alignment with sustainable finance goals. According to the ESAs, this area will receive more attention in the future iterations of this report. 

Scrutiny of auditors

In the future, PAI statements will also be subject to scrutiny by auditors. If regulatory requirements are not met, this will be documented in the external auditor’s annual report. This is an area that national supervisory authorities, such as the German BaFin, are increasingly focusing on, especially in the context of greenwashing.

SFDR Review

Another development to watch out for is the current consultation of the SFDR review, which, among other aspects, will evaluate the benefits and proportionality of the “administrative burden" related to the PAI regime as well as whether the functioning of SFDR is inhibited by the lack of data or their suboptimal quality, including in respect of PAI indicators.


financial institutions, investment fund services, private capital, regulatory, sustainable finance