The European Securities and Markets Authority has published three explanatory notes pulling together the relevant guidance on three fundamental concepts of the EU Sustainable Finance framework, being the use of estimates, the relationship between sustainable investments and investment in Taxonomy-aligned economic activities and the "do no significant harm" principle. These concepts are used in the Taxonomy Regulation, the Sustainable Finance Disclosure Regulation and the Benchmarks Regulation in relation to the two climate benchmarks.
- On 22 November 2023, the European Securities and Markets Authority (ESMA) published three explanatory notes on topics which relate to the EU Sustainable Finance framework on:
- The use of estimates and equivalent information under the EU Taxonomy Regulation (TR), the EU Sustainable Finance Disclosure Regulation (SFDR) and the Benchmarks Regulation (BMR);
- Sustainable investments under SFDR and investments in Taxonomy-aligned economic activities under TR; and
- The "do no significant harm" (DNSH) principle under SFDR, TR and BMR.
- The notes do not contain any new guidance but are meant to provide a comprehensive overview of all guidance and explanations provided by various European authorities until today. This is a welcome support to the financial services industry which has struggled to keep on top of the many different Q&As, briefings, guidelines and statements issued by European authorities since SFDR was enacted on 10 March 2023. It also serves one of the overarching topics identified by the European Commission in its ongoing consultation on a review of SFDR, being interoperability between different components of the EU Sustainable Finance framework (for more information see our blog post here).
- We have summarized each of the notes in a table set out below:
Use of estimates and "equivalent information"
- Due to their different purpose and their genesis at different development stages of the EU Sustainable Finance framework, each of TR, SFDR and BMR use a different concept for the use of estimated ESG data. This is why the European Supervisory Authorities (ESAs) have suggested to simplify and align the concept of "equivalent information" under SFDR in their consultation on reviewing the SFDR implementing provisions which ran until 4 July 2023 (for more information see our blog post here). As an example, it would be currently possible to classification an investment as Taxonomy-aligned under SFDR based on "equivalent information" while this data cannot be considered for the same classification under TR.
- The table below summarizes the guidance provided by ESMA and contains some additional information based on our practical experience:
| Taxonomy Regulation (TR) | Sustainable Finance Disclosure Regulation (SFDR) | Benchmarks Regulation (BMR) | |
| Who uses the concept? | All undertakings required to publish a non-financial statement under EU sustainability reporting rules (NFRD/CSRD)[1] | FMPs when making disclosures on (i) Taxonomy-aligned investments or (ii) principal adverse impacts of investment decisions on sustainability factors (PAI) in a financial product | Benchmark administrators, in particular for EU Climate Transition Benchmarks (EU CTBs) and EU Paris-aligned Benchmarks (EU PABs) |
| What is the concept? | "Estimates" covers all data which is not publicly reported under NFRD/CSRD by the investee company |
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Distinction between reported and estimated data when disclosing the data sources used |
| When is the concept applied? | As a basis for voluntary reporting on the Taxonomy eligibility or Taxonomy alignment of investments in companies not reporting under NFRD/CSRD |
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Benchmark administrators must disclose data sources used and whether data is estimated or reported |
| What are the requirements for applying the concept? |
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Sustainable investments and investments in Taxonomy-aligned economic activities
The differences and the relationship between sustainable investments under Art. 2 no. 17 SFDR and investments in Taxonomy-aligned economic activities under Art. 3 TR (also called "environmentally sustainable activities") has been a constant point of agitation since SFDR came into force. The European Commission has recently helped to calm the waves a bit by confirming that investments in Taxonomy-aligned economic activities are always sustainable investments and that no additional assessments are required under SFDR (provided that the entire investment is made in a Taxonomy-aligned economic activity). For more information on this so-called "safe harbour" see our blog here.
We have summarized ESMA's explanation of the parameters of each of the concepts below:
| Taxonomy Regulation (TR) | Sustainable Finance Disclosure Regulation (SFDR) | |
| Who uses the concept? | All undertakings required to publish a non-financial statement under NFRD/CSRD | FMPs that offer financial products under SFDR which make sustainable investments |
| What is the concept? | A Taxonomy-aligned economic activity must meet the following cumulative criteria:
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A sustainable investment must meet the following cumulative criteria:
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| When is the concept applied? | The determination is made by the reporting undertaking for each of its economic activities and relates only to environmental objectives | The determination is made by the FMP for each of the investments in a financial product under SFDR and relates to either environmental or social objectives |
| What are the requirements for applying the concept? |
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The DNSH principle under TR, SFDR and BMR
The DNSH principle is an important element of the EU Sustainable Finance framework. It stems from the principle of double materiality embedded throughout the framework (e.g. also in the new European Sustainability Reporting Standards (ESRS), see our blog post here). It requires undertakings and FMPs to assess not only financially material risks and opportunities for the undertaking or the investment, but also the impact caused on the external stakeholders such as the environment, workers or communities. Named (almost) the same under all three regulations, the concepts underlying DNSH in these three regulations differ significantly which has been a constant cause for confusion in the market.
We have summarized ESMA's explanation of the DNSH concepts under TR, SFDR and BMR below:
| Main questions | Taxonomy Regulation (TR) | Sustainable Finance Disclosure Regulation (SFDR) | Benchmarks Regulation (BMR) |
| Who uses the concept? | All undertakings that are required to publish a non-financial statement under NFRD/CSRD | FMPs that offer financial products under SFDR making sustainable investments | Benchmark administrators of EU CTBs and EU PABs. |
| What is the concept? | DNSH assessment is applied at the level of the economic activity and checks compliance with the TSC for DNSH defined for the respective economic activity in the TR delegated acts | DNSH assessment is applied at the level of the investment and is based on two elements, being (i) taking into account PAI for the investment and (ii) ensuring alignment of the investee company with the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles for Business and Human Rights |
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| When is the concept applied? | As part of the assessment whether an economic activity is Taxonomy-aligned (see above Section 0) | As part of the assessment whether an investment in a financial product qualifies as sustainable investment | When constructing and adjusting the EU CTB or EU PAB portfolio |
| What are the requirements for applying the concept? |
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Benchmark administrators must ensure that the portfolios used for EU PAB or EU CTB do not contain any companies which should be excluded as described above |
Less or more confusion?
It remains to be seen whether these notes will help to chart the growing jungle of regulatory guidance, explanations and clarifications. It is definitely a good starting point to assemble such information based on concepts rather than on the date of their publication. However, some of the statements made show that ESMA is also struggling to identify a path in the undergrowth and provide clear information on the three concepts – an unfortunate situation very well known to many market participants.
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Disclaimer
The articles published on this website, current at the dates of publication set out above, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action.