PAI - what is this and how to report it?
The Sustainable Finance Disclosure Regulation (SFDR) still raises many questions. We are still learning how to understand them and how to implement them, even though they have been in effect since 2021. To facilitate this, in July last year, the European Commission, published a set of guidelines (called technical standards "RTS"), which are contained in Delegated Regulation 2022/1288, supplementing the SFDR. They clarify and explain the form and content of the obligations that the SFDR imposes on financial entities. The new delegated act regulates a number of issues, including, but not limited to, how to disclose a financial company's approach to the Principle Adverse Impact (PAI) of investment decisions on sustainable development.
What the PAI is?
PAI are a part of the SFDR, which regulates sustainable finance. They are intended to establish reporting standards and draw the attention of financial market participants to possible sustainability risks arising from their investment decisions. The issue is such consequences of investment decisions and investment advisory services that have an adverse impact on environmental, social and labor and management factors, i.e. those concerning, for example, respect for human rights, or anti-corruption and anti-bribery.
What should be disclosed?
PAI should be disclosed both at the entity level and at the product level.
Subject-level disclosures. First of all, it should be pointed out that PAI disclosures apply to those entities that have declared as part of their SFDR Article 4 disclosures that they take major adverse impacts into account when making investment decisions. Disclosures on major adverse sustainability impacts should be published by the entity on its website. They should explain what adverse impacts are taken into account when making investment decisions and what measures are being taken to prevent these possible adverse impacts. This does not mean that since we do not declare to take PAI into account in our investment activities we have the problem solved. In such a situation, we need to give specific reasons why PAI has not been taken into account and whether we are considering taking it into account in the future.
Subject disclosures should be prepared based on the three tables in the appendix to the RTS. They contain a total of 44 PAI indicators, of which 18 are mandatory (Table 1) and the rest are optional (Tables 2 and 3). However, also from these (i.e., from Tables 2 and 3), at least one indicator each must be selected and reported. In addition to the indicators, the table also includes their descriptions to make them easier to understand. The mandatory indicators include:
greenhouse gas emissions - broken down into Scope 1, 2, 3 emissions,
carbon footprint,
exposures to fossil fuel companies,
gender diversity on company boards,
violations of UNCG rules, OECD Guidelines for Multinational Enterprises.
The indicators are disclosed by sustainability factors, viz:
climate and environmental issues,
social and labor issues, related to respect for human rights and commitment to anti-corruption.
Indicator data should also include historical values from the previous period and an indication of the actions taken by the company with regard to the identified impacts.
Product-level disclosures. For product-level disclosures, according to Article 7 of the SFDR, financial companies that do not take PAI into account must indicate the reason for this approach in their pre-contract disclosure documents. And if they do take PAI into account then they must detail in their pre-contract disclosures how each of their financial products takes PAI into account. Information on PAI is part of the disclosures for "light green" products (i.e., those that promote an environmental or social aspect), which are described in SFDR Article 8, and "dark green" products (i.e., those that aim for sustainable investment), described in SFDR Article 9. Disclosures at the product level also need to be developed based on the tables that are attached to the RTS and explain whether and how the product addresses the main adverse sustainability impacts, and in the case of disclosures in documents provided before the contract is signed, indicate where (e.g., a link) such disclosures are located.
What and when?
Starting as early as December 30, 2022, financial institutions must disclose, in accordance with Article 7 in pre-contract documents, how they take PAI into account for each individual product. They should also publish the same information in anniversary information sent to customers. On the other hand, by June 30, 2023, PAI tables and a description of the methodology adopted should be published on the website. Information published by June 30 should include data for the period from January 1, 2022 to December 31, 2022. And the same for subsequent years.
The other side of the coin
Although disclosures under SFDR and including PAI apply to financial entities that carry out investment activities, they also indirectly affect other companies. The companies in question are those that issue securities that may be included in an investor's portfolio. The investor, in order to obtain the information necessary to report PAI, must obtain it in some way. How will he do it? He can use the annual reports published by these companies or external databases, but he can also - and this will probably be a fairly common practice - apply directly to a specific company with a request for specific data. Therefore, in order to avoid filling out dozens of questionnaires from investors, "non-investment" companies are beginning to publish tables of PAI data on their websites or attach them to non-financial annual reports. This is a good practice, as it saves valuable time. It is worth considering, and preferably implementing....