In this quarterly update, we focus on the key regulatory changes for the UK and Europe with specific focus on ESG, sustainable finance, performance data for PRIIPs and the new Task Force on Climate-Related Financial Disclosures (TCFD).

General Market Insight to the end of 2022

The year certainly feels like it is moving quickly and we already find ourselves in quarter three. Normally summer represents a quieter, and more reflective time in the regulatory space. This year, however, the unrelenting pace has continued. So, what should we consider, or look out for towards the end of 2022?

Sustainable Finance, or ESG, has shown no sign of slowing and developments continue to come thick and fast. Up first is the only hitherto effective regulation, the Sustainable Finance Disclosure Regulation (SFDR):

• Principal Adverse Impact (PAI) disclosure: Principal Adverse Impact (PAI) disclosure: A key report¹ was published on the 28th July by the European Supervisory Authorities (ESAs) relating to the voluntary disclosure of PAI under the SFDR. Despite no specific actions planned, the report surveyed over 30 firms who are not obligated to report PAI (due to having under 500 employees). The output showed that the quality of disclosures varies significantly, and it was not possible to draw conclusions based on the size, nature and scope of activity. Disclosures were also lacking detail, with firms not providing clarity for why they do not consider PAIs. The findings of this report may be useful to firms when considering their own disclosures going forward.

• Template disclosures: Template disclosures: We are expecting to see amendments to the SFDR RTS disclosures that will include exposure to fossil gas and nuclear energy activity. The ESAs are currently working on amendments to the disclosures in pre-contractual documents, websites, and in periodic reports. There was a requirement to provide the amendments to the European Commission (EC) by 30th September however the amendments will not go under the usual route of public consultation, due to time constraints. Any amendments will have an impact on both Article 8 and 9 product disclosures. This may be an issue in Luxembourg, for example, where the Luxembourg Regulator, the CSSF², has requested all SFDR prospectus amendments to be issued to them by 31st October. The time is ticking!

• Questions & Answers: After the publication of the RTS a Q&A generally follows. There is a large volume of Q&A expected to be published to help firms ensure they are correctly interpreting the Directive and it is expected that it will be published in October. It should be noted that despite the aim of helping interpretation, in practice there may be divergence from what firms have understood and therefore further assessment and action may be required.

What about the other regulations; is it only ESG that is in focus? There have been amendments to existing regulation, however the material focus still remains on building sustainable finance across Europe and the UK. So, what are the key changes and considerations?

• MiFID Suitability Preferences: On the 2^nd August the MiFID and Insurance Distribution Directive (IDD) changed to ensure that sustainability preferences are considered in the suitability process, when providing advice. There has been a mixed uptake across the EU, with some jurisdictions not requiring this to be enacted until 2023. Despite this, we expect to see final guidance from ESMA in quarter four. As highlighted previously, additional guidance is always welcome but this may differ from firms’ original interpretation and require further work.

• MiFID Product Governance: Investor protection is always a topic that is at the forefront of regulation, and with the focus on sustainable finance there is product governance change in the pipeline. On the 14th October, there was an open hearing by ESMA on the MiFID product governance consultation paper, which was released in July and closed for comment on 7th October. This will consider: how a product’s sustainability-related objectives are specified; identifying a target market per cluster of products, rather than individual products; and, the consideration of what a compatible distribution strategy should be where a distributor considers that a more complex product can be distributed under non-advised sales. Expect future policy changes, impacts on your product lifecycle processes, and alterations to EMT in 2023!

• The focus on Greenwashing: The European Supervisory Authorities (ESAs) received a request from the EC to provide input into greenwashing risks and supervision of sustainable finance policies. The ESAs, in collaboration with each other and National Competent Authorities (NCAs), are to analyze market and supervisory practices. This will be done using a variety of tools such as thematic and desk-based reviews, as well as consultations. The scope of the analysis is not limited to specific regulations and instructs the ESAs to call out any greenwashing risks in their sectors. They must provide an interim report after one year and a final report after two years. The near-term impact to firms would most likely be if NCAs select them for an information request. In the longer-term we are likely to see good and bad practices being identified and supervisory expectations being raised. 

• Consumer Duty: In addition to ESG, we have seen the FCA’s Consumer Duty policy statement and guidance published on the 27^th of July. As a reminder, the Consumer Duty aims to set higher and clearer standards of consumer protection across financial services and require firms to put their customers’ needs first. Some have described this as an equivalent undertaking to MiFID II. Although the FCA is extending the implementation timeline by three months to July 2023, there are subtleties within the Rules that need to be considered carefully. The first deliverable is, in fact, expected by the end of October 2022 and a key deliverable for product manufacturers by the end of April 2023.

Consumer Duty key dates:

• 31^st October 2022: Boards are expected to have agreed on an implementation plan, identifying challenges to ensure they are deliverable, and appointing a consumer duty champion on the Board – likely an independent non-Executive Director (iNED).

• 28^th April 2023 – July 2023: A review of the four outcomes by manufacturers, and how these will be met, is required for all existing products by the end of April 2023. The process should identify any changes required and that firms should remedy them by July 2023.

The European ESG Template (EET) – considering the complexities

The first version of the EET was prepared to accommodate the exchange of a limited set of data points for the purposes of the 2^nd August MiFID and IDD changes to the suitability assessment process. It is expected that, during quarter three and four, firms will complete the EET with more granular information required under SFDR RTS which apply from 1^st January 2023.

The EET structure was based on draft SFDR RTS, however the final RTS published in July were unchanged. Therefore, amendments to the EET V1 are likely to be only minor clarifications and enhancements. The complexity for firms will be the amount of additional data to complete once they have complied with the full detail of the disclosures required under the SFDR RTS. Work is already underway on the EET V2 and on 31^st August there was a meeting of the FinDatEx working group to gather industry experience to date. Weekly meetings have been held throughout September and beyond to further enhance the EET.

It is clear that there is still confusion on how to complete data fields, and distributors and insurers are finding problems with the templates they receive. How firms complete the template with regards to interpretation of sustainable investments, taxonomy alignment, and translation could have implications on the filtering and selection process carried out by distributors and insurers.

Understanding what the insurer or distributor is looking for in the EET is fundamentally important as there remain ambiguities and differences of interpretation on the template, as well as the regulation. If expectations are different, this may result in misaligned understanding of how the template is completed, even if product documentation is compliant.

PRIIPS – Full Steam Ahead for 1st January 2023

From January 2023, the PRIIPs RTS (European Commission C(2021) 6325 final, requires financial market participants to publish the fund’s past performance and prior performance scenario calculations to a public website. This also needs to be referenced via a URL in the PRIIPs KID under the “Other Relevant Information” section. The past performance data is to be updated annually, while the performance scenario calculations data is to be updated monthly.

By doing so, the additional insights will help investors compare products more easily, by making their potential performance and associated risks more transparent. This will affect all asset managers who are presently preparing PRIIPs KID, and those who are marketing their UCITS KIIDs in Europe.

In other PRIIPs news, the European PRIIPs Template (EPT V2.1) has been launched to accommodate the new UK PRIIPs regime, as amended by FCA in March 2022. The EPT V2.1 is now live and includes an additional section required for the UK market. Despite the inclusion of UK specific information, it is expected that the EPT V2.1 and EPT V2.0 will coexist.

The UK government’s adoption of Task Force on Climate-Related Financial Disclosures (TCFD)

On 29^th July, the FCA published their findings from a review of the first climate related disclosures made in compliance with their rules under PS20/17. The rules applied to premium-listed commercial companies, and to their disclosures from the start of 2022. These companies are required to include a statement in their Annual Financial Report (AFR) on whether they have made disclosures consistent with the Task Force on Climate-Related Financial Disclosures’ (TCFD) recommendations, on a comply or explain basis.

The review was carried out jointly, with the Financial Reporting Council (FRC) who also published a separate analysis of the disclosures of 25 premium listed companies, weighted towards larger companies in climate-intensive sectors

The FCA was broadly pleased with the improvements and consistency of disclosures with the TCFD framework, but provided a list of areas for firms to be aware of and encourages firms to refer to the examples of better practice in the FRC’s complementary thematic review report.

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Broadridge Fund Communication Solutions has extensive expertise in managing fund data and understands the challenges involved. We offer ESG, MiFID II and PRIIPs KID solutions, providing complete support for all aspects in the composition, maintenance and document distribution of documents in all jurisdictions. Benefit from increased operational and cost efficiencies across your business with Broadridge Fund Communication Solutions as your single digital platform, supporting all your data, documents and regulatory reporting needs across the life cycle of funds.

_{1 ESAs issue report on the extent of voluntary disclosure of principal adverse impact under the Sustainable Finance Disclosure Regulation (europa.eu)}

_{2 Commission de Surveillance du Secteur Financier}