The European Supervisory Authorities--the European Banking Authority (EBA), European Insurance and Occupational Pensions Authority (Eiopa) and the European Securities and Markets Authority (Esma)--on 30 October 2024 their third annual report analysing principal adverse impact (PAI) disclosures under the Sustainable Finance Disclosure Regulation (SFDR). This 59-page assessed the quality and accessibility of disclosures made by financial institutions and product providers, examining their efforts to reveal the negative impacts of investments on sustainability and the actions taken to mitigate them.

The 2024 report highlighted that, overall, there was progress in the quality of PAI disclosures among financial institutions. As part of this, the ESAs noted that financial market participants (FMPs) had improved the accessibility of these disclosures, with a general improvement in the quality of information provided by financial products. Several national competent authorities (NCAs) also reported slight progress in SFDR compliance within their jurisdictions.

Disclosure obligations

The SFDR requires financial market participants with over 500 employees to disclose PAIs of their investment decisions. Smaller FMPs may opt out of this requirement but must explain their reasoning. Should they choose to disclose, they must use the level 2 template stipulated in annex I of the SFDR delegated regulation, effective from January 2023.

The ESAs’ latest report builds on previous analyses of voluntary PAI disclosures. The 2022 report revealed low compliance with PAI disclosure standards, with smaller institutions particularly struggling. The 2023 report saw incremental improvements, particularly in accessibility, yet FMPs continued to face challenges in clearly addressing how they considered PAI indicators. Although disclosures of product-level PAI information became mandatory as of December 2022, a lack of consistency in voluntary disclosures still hindered comparability.

In preparing the latest report, the ESAs conducted a survey among NCAs within its joint committee. This survey gathered data on both entity-level and product-level voluntary PAI disclosures, as well as the application of the new SFDR delegated regulation template, introduced on 30 June 2023. The report incorporated three main data sources: NCA survey responses, qualitative assessments of 65 entity-level PAI statements and quantitative data from Morningstar on product-level PAI disclosures from investment funds, collected via the European ESG Template (EET) in July 2024.

Key findings

The ESAs observed significant progress in both qualitative and quantitative aspects of NCA responses, covering a larger number of FMPs compared to previous years. The report indicated that disclosures were increasingly accessible to retail investors, and improvements in the quality and location of information reflected positively on the overall state of PAI disclosures. Product-level PAI disclosures also showed notable enhancements. However, the proportion of products disclosing SFDR PAI information remained relatively low.

Despite this progress, the ESAs concluded that compliance with SFDR requirements was still unsatisfactory, particularly regarding level 1 requirements and implementing measures. Although both NCAs and FMPs had made significant efforts toward compliance, further improvements were necessary. NCAs, in particular, engaged FMPs who were non-compliant or only partially compliant, using the results to inform their risk-based approach to SFDR-related supervision.

Recommendations

Looking forward, the ESAs advised NCAs to work towards greater convergence in the supervision of SFDR disclosures across the EU. Additionally, the ESAs encouraged the European Commission to consider their findings when conducting a comprehensive review of the SFDR. The report recommended that the frequency of the ESAs’ PAI assessments under the SFDR be reduced from annually to every two or three years. This, the ESAs argued, would allow for a more resource-efficient and meaningful analysis of PAI disclosures, building on lessons from past reports.

The report also identified several good and bad practices concerning PAI disclosures, derived from NCAs’ responses and the ESAs’ evaluations. Examples included best practices in the clarity and complexity of disclosure content, which may serve as a reference for future improvements.