SFDR on course for significant change in ESAs’ Consultation Paper


On 5 April 2023, the European Commission (“EC”) published its long-awaited Q&A document clarifying key points relating to the Sustainable Finance Disclosure Regulation (“SFDR”), in particular regarding the definition of “sustainable investments” and “consideration of the principal adverse impacts” (the “Q&As”).

Shortly afterwards, the European Supervisory Authorities (“ESAs”) published a joint consultation paper on 12 April 2023, in which significant changes were proposed to SFDR and its regulatory technical standards (“SFDR Level 2”). 

The consultation paper comes in response to the EC’s mandate to the ESAs to address the main technical issues that have emerged since the implementation of SFDR and request for proposed amendments to SFDR Level 2 to include disclosures on greenhouse gas (“GHG”) emissions reduction targets.

However, going beyond the EC’s mandate, the ESAs have taken the opportunity to propose further amendments to SFDR and SFDR Level 2 in order to address other issues and weaknesses they have identified. These include proposals on disclosures of principal adverse impacts (“PAI”) and the do no significant harm principle (“DNSH”), the simplification of the current templates and a number of technical adjustments to facilitate the use of the templates and the application of the standards.

The consultation is open for responses until 4 July 2023.

Our summary of the Q&As key elements and the most significant proposals suggested by the ESAs is set out below.  

I. EC’s answers to ESAs’ questions on the interpretation of SFDR

The ESAs previously submitted several questions to the EC seeking clarification on the interpretation of certain aspects of SFDR. The Q&As published by the EC respond directly to these questions and provide helpful clarity, most notably, in relation to:

  • The definition of “sustainable investment”: the EC has helpfully clarified that the approach for classifying investments as “sustainable investments” shall be left to the discretion of financial market participants (“FMPs”) provided the methodology undertaken by FMPs is adequately disclosed and clear enough so as not to mislead investors.  This also applies to the level at which a product is assessed in order to determine whether it does in fact constitute a “sustainable investment” – for example, whether at the company level or the level of the economic activity – and it was once again left to the discretion of FMPs to make this assessment provided the methodology is adequately disclosed. This flexibility displayed by the EC reiterates the fact that SFDR is not intended to be a prescribed regime and transparency and disclosure remain at the heart of the regulation.

    With regard to transitioning assets and the DNSH principle within the definition of “sustainable investment”, the EC confirmed that referring to a transition plan aiming to achieve the objective that the whole investment does not significantly harm any environmental or social objectives in the future is not sufficient to meet the definition under Article 2(17) SFDR. 
  • Products with carbon emissions reduction strategy: the EC clarifies that products that have  reduction in carbon emissions as their objective can fall within scope of Article 9(3) SFDR whether they are actively managed or passively track the Paris-Aligned Benchmark or Climate Transition Benchmarks. Actively managed funds would, however, have to comply with the Article 2(17) sustainable investment test.

    The EC also confirms that Article 8 products may disclose carbon emissions reduction as an environmental characteristic, and not solely an environmental objective, provided their disclosures and marketing materials do not mislead investors into thinking that the product has a carbon emissions reduction objective.
  • Consideration of PAI: the consideration of principal adverse impacts (“PAI”) for the purpose of Article 7 SFDR should differ from the consideration of PAI at the level of the FMP (Article 4 SFDR) and the consideration of PAI for the purpose of meeting the DNSH, as already clarified by the ESAs1. In the Q&As, the EC clarifies that the consideration of PAI triggers the obligation to include both a description of the PAI considered and the procedures put in place to mitigate such impacts.

The EC also took the opportunity to slightly amend the previous set of Q&As published  on 6 July 2021 and 13 May 2022.

II. EC’s answers to ESAs’ requests on the interpretation of SFDR

1) Updates to PAI reporting

One of the most significant proposals suggested by the ESAs is clarification on PAI reporting.

  • Value chains: The ESAs are providing some much sought-after clarity on whether PAI calculations should incorporate contributions to adverse impacts throughout the value chains (aka supply chain) of investee companies. In an effort to align with the Corporate Sustainability Reporting Directive (“CSRD”), it proposes to only require financial market participants (“FMPs”) to incorporate investee companies’ value chains into their own PAI calculations where the investee company themselves reports on this under CSRD, or where the information is readily available.
  • New social PAI indicators: A widening of the scope of both mandatory and opt-in social indicators is also proposed. The new mandatory social indicators proposed include: (i) amount of accumulated earnings in non-cooperative tax jurisdictions, (ii) exposure of companies in tobacco-related activities and (iii) workers and employees’ indicators such as formation of trade unions and adequate wage. The consultation paper further proposes to introduce a social PAI indicator applicable to the entity managing the real estate assets.
  • Derivatives: With regards to the use of derivative transactions by FMPs, which hedge risks through long exposure, the ESAs proposal is for derivative transactions to be included in the numerator of PAI calculations, with an exemption applicable only where FMPs can show such a transaction does not ultimately “result in a physical investment in the underlying security”.  Unlike the calculation of taxonomy-alignment or of sustainable investments, the risk of greenwashing for PAI calculation indeed stems from trying to minimise the numerator.

2) DNSH test for sustainable investments

The DNSH principle is a guarantee measure, designed to prevent investments which are claiming to be sustainable from achieving one marketable environmental or social objective at the expense of causing a host of other (hidden) environmental or social negative impacts. It is incorporated into the definition of “sustainable investments” under Article 2(17) SFDR.

However, as currently drafted, assessing whether an investment qualifies as sustainable involves a wide display of discretion and subjectivity. As a result, the ESAs note, in accordance with studies led by NGOs, that a substantial number of Article 9 funds have exposures to fossil fuels, particularly coal activities, heightening greenwashing concerns. The ESAs are also concerned with the comparability of financial products, both from the perspective of the disclosures published on DNSH and the frameworks FMPs adopt on DNSH, particularly given the limited predictability in relation to the application of PAI-based DNSH criteria.  Under the consultation paper, the ESAs propose a range of options in relation to DNSH:

  1. maintaining the status quo: preserving the current status quo would acknowledge that the SFDR Level 2 and Taxonomy regimes have only recently come into force and avoid further implementation efforts across the industry. That said, it would not address the weakness and namely the significant greenwashing risk of not having a rigorous disclosure DNSH regime.
  2. providing more specific disclosures: the ESAs suggest that quantitative thresholds used to determine whether the sustainable investments meet the DNSH test, should be disclosed via website disclosures. This would increase the transparency and comparability between financial products.
  3. introducing an optional “safe harbour” for environmental DNSH disclosures: under this proposal, the investments considered environmentally sustainable under Article 3 of the Taxonomy would be exempt from providing further DNSH disclosures.  However, sustainable investments with a social objective or sustainable investments with an environmental objective not aligned with the Taxonomy would still have to demonstrate compliance with the DNSH principle which would likely increase complexity.

3) Transparency on decarbonisation strategies

The proposals relating to decarbonisation (aka GHG emissions reduction) disclosures, if they came into force, could represent a significant repapering for many Article 8 and Article 9 financial products.

The ESAs, in trying to strike a fine balance between “detailed, decision-useful disclosures” and obligations which are “feasible and proportional for FMPs”, have suggested specific disclosures for carbon reduction commitments.  

Additional disclosures would be required where a product commits to GHG emissions targets including the level of ambition of those targets (and whether they are compatible with limiting global warming to 1.5 degrees), and the share of investments covered by the targets. 

The ESAs proposal would also differentiate between GHG emissions reduction targets which are (i) GHG emission reductions through divestment from investments with particular GHG emissions levels and reallocation of the investments towards companies with comparatively lower GHG emissions; and/or (ii) GHG emission reductions through investments in investee companies that deliver actual GHG emissions reductions over the duration of the investment, achieved also through engagement with investee companies.

Further developments on GHG emissions targets, including intermediate targets, would also be required.

Adequate changes to the periodic and website disclosures are also proposed by the ESAs, notably to report on progress to date and how the investment strategy contributed to such progress, and to disclose, in more detail, the process applicable for carbon reduction strategies.

Lastly, the ESAs call for distinct and separate disclosures on the purchase of carbon credits and their use.  The ESAs identify greenwashing concerns surrounding carbon credits and set out that it is critical that investors are duly informed regarding the use of such credits and their quality. The disclosures on carbon credits would include detailed information to be provided on websites.


4) Updates to the templates

Addressing criticisms levied at the complexity and length of the financial product templates, the ESAs have proposed various changes to the language, layout and structure of the pre-contractual and periodic reporting templates in an attempt to enhance the readability for retail investors and use more straightforward terminology.

As part of these updates, the ESAs have proposed the introduction of a “dashboard” to the template, which highlights crucial information arising from the pre-contractual disclosures and periodic reports and provides a snapshot of the key information for retail investors. The dashboard would be colour coded for ease of navigation and would contain:

  1. Minimum commitments for environmental/social characteristics or sustainable investment objectives, sustainable investments and Taxonomy-aligned investments in the form of a bar chart; and
  2. Boxes on sustainable investments; Taxonomy-aligned investments, PAI consideration and GHG emissions reduction (i.e. de-carbonisation targets).

The proposed dashboard for Article 8 products is as follows:

In light of the above proposal to include minimum commitments in the dashboard and to avoid any unnecessary repetition, the ESAs suggest that the dashboard could serve as a replacement for the “Asset allocation” section of the templates and its wire chart/graph.

Other adjustments are suggested to the template, namely:

  • to remove the ability for FMPs to adapt the colours in the pie chart and bar chart on Taxonomy-alignment;
  • to include electronic versions that would be extendable upon clicking each question;
  • to replace the ability to use “equivalent information” with “estimates”. In terms of the acceptable estimates that could be used, the ESAs request feedback on the Platform of Sustainable Finance’s Platform Usability Report.

In addition, the ESAs have requested feedback on whether more detailed specifications are required to support the calculation of the proportion of sustainable investments partly to address some of the concern around greenwashing in relation to “sustainable investments”.

Finally, there are detailed proposals from the ESAs for updates to periodic disclosures, and website disclosures for financial products with investment options with the ESAs proposal to standardise the approach, where possible.


The deadline for feedback on the consultation is 4 July 2023, however, the ESAs have not included an indicative timeline in the consultation paper for publishing the final rules. We will be keeping this under review and report on any developments as soon as they become available. 

CMS will also submit a response to the consultation – please contact Laura Houët, Aurélien Hollard or Julie Pelcé if you are interested in further information on our response or for further information on how the proposed developments may impact your firm and financial products.