Understanding Principal Adverse Impact (“PAI”) Disclosures Under the Sustainable Finance Disclosure Regulation (“SFDR”)

The Sustainable Finance Disclosure Regulation (“SFDR”) has been pivotal in guiding Financial Market Participants (“FMPs”) towards more transparent sustainability practices. Since 10 March 2021, SFDR has required FMPs and financial advisors to disclose their sustainability impacts to investors, promoting informed and responsible investment. Following the SFDR Delegated Regulation’s applicability on 1 January 2023, specific technical standards have further standardised these disclosures. On 30 October 2024, the European Supervisory Authorities (“ESAs”) released an annual report detailing current disclosure practices, identifying successes, and highlighting areas for improvement.

Key Findings on Entity-Level Statements

In assessing FMPs’ PAI disclosures at the entity level, the ESAs noted varying degrees of compliance. While many FMPs adhered to the prescribed templates in Annex I of the SFDR Delegated Regulation, there were discrepancies in methodology, making some disclosures difficult to compare. For example, reporting on energy consumption intensity was inconsistent across FMPs, complicating comparative analysis.

Additionally, the Report found that approximately 10% of FMPs did not address the required indicators, a critical lapse under SFDR, which mandates the completion of all indicators in Annex I, including at least one environmental and one social indicator from Tables 2 and 3. FMPs with strong disclosure practices clearly detailed their methodologies, data sources, and engagement policies. In contrast, others cited “lack of data” without offering alternative solutions or methods.

• Good and Bad Practices in Entity-Level Disclosures

The ESA report highlighted several effective and ineffective practices, outlining areas where clarity, accessibility, and regulatory compliance could be improved. We have set out these briefly below:

• Location of disclosures

In terms of the location of disclosures, good practices include FMPs that make their PAI statements easily accessible by dedicating a prominent section on their websites, often labelled as “Sustainability-related disclosures” or “SFDR.” This clear labelling facilitates transparency and allows investors to locate information quickly. However, some FMPs engage in poor practices by placing disclosures in hard-to-find sections of their websites or combining them with unrelated documents, often accessible only through search functions, which can create barriers for investors seeking this information.

DO: make accessible the entity level PAI statement in an easily identifiable area of your website (e.g. your Sustainability Disclosures page).

• Clarity of disclosures

The report praises FMPs that use simple, clear language and structured formats, often with introductory paragraphs that improve readability. Some FMPs enhance accessibility by providing multilingual options, making it easier for international investors to understand their sustainability impacts. On the other hand, several FMPs compromise clarity by using unexplained abbreviations or technical jargon, such as “ESG Commitment score,” without further clarification. These practices leave investors struggling to comprehend the full scope and meaning of the disclosures.

DO: use simple and clear language.

DON’T: use abbreviations or concepts without context.

• Completeness of disclosures

In evaluating completeness of disclosures, the ESA report highlights FMPs that comprehensively address indicators from Annex I, Tables 1, 2, and 3, as the SFDR guidelines require. Such thoroughness ensures investors receive a full picture of an FMP’s sustainability impacts. Conversely, some FMPs omit essential indicators or fail to disclose engagement policy details, frequently justifying these omissions by citing data limitations. This approach falls short of regulatory expectations, as FMPs are expected to address all mandatory indicators and outline their methods for handling conflicts of interest.

DO: address all mandatory PAI indicators.

DON’T: omit mandatory indicators.

• Compliance with the Annex I templates

The ESA report identifies good practices among FMPs that follow the standardised format without modification. These FMPs not only comply with SFDR’s requirements but also promote uniformity across the industry, aiding comparability. However, a subset of FMPs deviates from this format by adding unauthorised columns, altering the template, or claiming the template does not suit their business. Such modifications undermine the standardisation objective of SFDR, making it challenging to assess and compare PAI disclosures across different entities.

DO: use the template mandated by the ESAs.

DON’T: amend the template mandated by the ESAs.

• Quality of the statements

The quality of the statements is another area where practices diverge. FMPs with high-quality disclosures provide detailed statements that transparently outline data sources, methodologies, and, in some cases, historical comparisons, offering investors a comprehensive view of the firm’s sustainability impacts. In contrast, some FMPs offer incomplete disclosures with errors in PAI calculations, overly extensive summaries, vague engagement policies, and an absence of historical context, all of which reduce the effectiveness of their PAI statements.

DO: provide comprehensive statements.

DON’T: include irrelevant, incomplete, vague and confusing information.

• Quantification of actions taken under the relevant column in Annex I of the SFDR Delegated Regulation

The ESAs commend FMPs that set measurable targets and milestones, allowing investors to track progress over time. These FMPs provide a clear framework for assessing the efficacy of their sustainability efforts, adding value to the disclosure process. However, other FMPs offer only generalised statements without specific or measurable goals, making it difficult for investors to evaluate the impact of their sustainability initiatives. The absence of quantifiable targets leaves little basis for assessing the consistency and progress of these FMPs’ commitments.

Overall, the ESA report highlights that while there are several examples of good practices that contribute to effective PAI disclosures, there remain significant areas for improvement. FMPs are encouraged to adopt the best practices observed in these areas to align with SFDR’s transparency objectives fully.

DO: provide information to allow investors to compare the progress over time.

DON’T: use generalised statements and non-quantifiable targets and measurements.

Financial Product-Level PAI Statements

At the product level, FMPs disclosed PAIs for their financial products as required by Article 7 of the SFDR. However, specific indicators—such as “emissions to water,” “hazardous waste,” and “gender pay gap”—showed low coverage, largely due to data limitations. Smaller FMPs, in particular, cited limited resources as a barrier to complete and accurate reporting.

FMPs connected to larger financial groups tended to provide more thorough disclosures, a trend that highlights the need for improved data access and capacity-building support for smaller firms.

Voluntary Disclosure Assessment

The ESAs observed progress in voluntary disclosures, with FMPs linked to multinational organisations often providing more detailed information. However, FMPs without PAIs commonly cited data or resource limitations, with no clear timeline for when they would begin considering PAIs, an issue flagged as unsatisfactory in previous reports. Visibility and accessibility remain challenges for some FMPs, and there is ongoing confusion about mixing sustainability risk integration with SFDR disclosures.

Conclusion

The 2024 ESA report underscores both successes and areas for improvement within the SFDR’s PAI disclosure framework. FMPs, regardless of size, must prioritise clarity, accessibility, and completeness to ensure their disclosures offer real value to investors. Increasing data availability through initiatives like Corporate Sustainability Reporting Directive (“CSRD”) and European Sustainability Reporting Standard (“ESRS”) will further enhance disclosure quality, creating a more transparent and responsible investment landscape.

The European Commission may wish to review the ESAs’ findings as part of its broader assessment of the SFDR’s effectiveness. In line with recommendations from the Joint ESAs Opinion, the ESAs are also advocating for a reduction in the frequency of PAI disclosure assessments—from annually to every two or three years. The ESAs believe that while the reports are valuable, a less frequent schedule would enable both ESAs and NCAs to allocate resources toward deeper, more impactful analyses of PAI disclosures and to better leverage insights from past assessments.

In any event, FMPs are encouraged to follow best practices and ESA guidance to meet evolving expectations and foster transparency and accountability in sustainable finance.

The Zeidler Legal Team are here to assist with any questions or support you may need regarding SFDR. Contact us for more information.