SFDR introduces new sustainability disclosure obligations for Irish pension schemes

• Ireland

• Pensions
• The future of funds - ESG
• The future of funds - Regulatory

05-03-2021

An increasing requirement for Irish pension trustees to consider the sustainability of their investments has already been flagged under both the IORP II Directive (not yet in force in Ireland) and the EU (Shareholders’ Rights) Regulations 2020, implementing the amended Shareholder Rights Directive (“SRD II”). 

In this regard, IORP II and SRD II can be considered as appetisers. The main course, SFDR, will be coming into force with effect from 10 March 2021.

What is SFDR?

SFDR is the Sustainability Related Disclosures in the Financial Services Sector Regulation, Regulation (EU) 2019/2088.

It is part of a very wide ranging programme of legislation being introduced by the European Commission to support the EU’s goal of becoming the world’s first climate neutral continent by 2050.

The purpose of SFDR is to seek to regulate and ensure the consistency of disclosures on sustainability by financial market participants (“FMPs”), both generally and in relation to specific financial products.

How does it apply to pension schemes?

There is no question that EU legislators intend this legislation to apply fully to EU pension funds.

The definition of a financial market participant (FMP) under SFDR includes IORPs, with two qualifications.  Specifically, all IORPs to which the IORP II Directive is fully applicable under local law, and which operate pension schemes which together have 15 members or more, are FMPs for the purpose of SFDR.

As the IORP II Directive has not yet been implemented, there remains doubt as to which Irish pension schemes will fall within this definition. However, as an EU Regulation, SFDR is directly effective once it comes into force on 10 March 2021, and therefore must be addressed by Irish pension trustees. 

The IORP II Directive also requires the Irish legislature to decide whether it is the individual pension scheme or the trustees of that scheme which constitutes the “IORP” for Irish law purposes. Under SFDR, the IORP as an FMP is distinguished from the financial product or products it may offer, which include “pension schemes”.

A pension scheme is in turn defined by reference to the IORP II Directive, which defines it as follows:

‘pension scheme’ means a contract, an agreement, a trust deed or rules stipulating which retirement benefits are granted and under which conditions.

These issues of interpretation will only be fully resolved once IORP II is implemented in Ireland, but in the meantime trustees should take a pragmatic approach to the application of SFDR to their schemes.

For the remainder of this briefing, we will equate an “IORP” for Irish purposes with the trustees of the relevant pension scheme.

What Disclosures are required under SFDR?

The disclosure obligations under SFDR encompass the “pre-contractual stage”, in other words the information to be disclosed to new members joining the scheme, periodic or annual reporting requirements, and finally the publication of certain disclosures on the trustees’ website.

The concept that Irish trustees now have to operate websites or have access to a website on which they can publish disclosures was introduced under the Shareholders’ Rights Regulations last year, and will become more widely applicable when IORP II is implemented into Irish law.

There are two broad heads to the SFDR disclosures which trustees must make.

Sustainability Risk

SFDR firstly creates obligations regarding the disclosure of policies on sustainability risks. Trustees are required to publish on their websites information about their policies on the integration of sustainability risks in their investment decision making processes.

Sustainability risks are defined as environmental, social or governance events or conditions that, if they occur, could cause an actual or potential material negative impact on the value of the investment.

In addition, trustee remuneration policies (which are the remuneration policies which trustees will be required to have in place following the implementation of IORP II) must include information on how the remuneration policy integrates sustainability risks. This information will also need to be published on the trustee website.

The ambit of a trustee remuneration policy is a little unclear until IORP II is specifically implemented into Irish law, but under the Directive itself it covers persons who effectively run the IORP, carry out key functions and other staff whose professional activities have a material impact on the risk profile of the IORP.

The disclosure requirement could, therefore, extend to remuneration policies in relation to function holders such as the scheme actuary.

Trustees are also required to include descriptions of the manner in which sustainability risks are integrated into their investment decisions, and the results of assessments made of the likely impacts of sustainability risks on the returns of the financial products they make available.

As previously indicated the definition of “financial product” includes a pension scheme, as defined above.

Adverse Impacts

While the disclosures on sustainability risks are focused on the potential impact on the investment performance of the scheme of ESG related risk factors, the second limb of the Regulation focuses on the impact of the pension scheme’s investment decisions on the wider environment.

Trustees are required to publish and maintain on their websites, information in relation to the consideration of principal adverse impacts of [their] investment decisions on sustainability factors. 

Sustainability factors are defined as environmental, social and employee matters, respect for human rights, anti-corruption and anti-bribery matters.

In relation to adverse impacts, the Regulation follows a comply or explain format. Where trustees consider principal adverse impacts of their investment decisions, then they must publish a statement setting out certain prescribed information regarding how they identify and prioritise impacts and what actions they take to mitigate such impacts. However, if trustees do not consider adverse impacts when making their investment decisions, they need to publish, in respect of each pension scheme, a statement confirming this. This statement must provide clear reasons for not doing so including whether or when the trustees might intend to consider such impacts. 

FMPs which have more than 500 employees on average will, after 30 June, not have this opt out right. This appears inapplicable to any Irish trustees.

While the disclosure requirement at trustee level is applicable from the coming into force of the Regulation on 10 March 2021, the disclosure obligation at pension scheme level does not technically apply until 30 December 2022.

Product Specific Disclosures

Certain financial products may come within the ambit of Articles 8 and 9 of the Regulation. These products have enhanced disclosure requirements because of their particular characteristics. 

Article 9

Article 9 relates to any financial product (including a pension scheme) that has sustainable investment as its investment objective. It may be assumed that there would be very few Irish pension schemes which would fall within the scope of Article 9, although there may be individual investment choices or investment funds within a scheme’s portfolio that have sustainable investment as their investment objective. 

Sustainable investment is defined as an investment in an economic activity that contributes to an environmental objective or a social objective provided that such investments do not significantly harm any of these objectives and that the investee companies follow good governance practices.

Article 8

Article 8 applies to financial products (including pension schemes) that promote social or environmental characteristics, among other characteristics.

This is a more nebulous definition, and there has been much debate within the asset management industry as to what the scope of Article 8 truly is. Clearly, a pension scheme which has an ESG focus or emphasis as part of its investment strategy towards satisfying its overall retirement savings purpose could potentially fall within Article 8.

In particular, the concept of what constitutes “promotion” has not yet been clearly defined by the European Commission, and in fact the European Supervisory Authorities, including EIOPA, have expressed concern on this.

The disclosure requirements applicable to pension schemes falling within the above categories will be significantly more onerous than for other schemes, so it is important for trustees to assess whether their schemes might fall within the Article 8 or 9 categories.

Role of the ESAs

The European Supervisory Authorities are the European Banking Authority (“EBA”), the European Insurance and Occupational Pensions Authority (“EIOPA”) and the European Securities and Markets Authority (“ESMA”).

Under the Regulation the ESAs are obliged to draft regulatory technical standards to specify the content and presentation of SFDR information. In effect, these are the statutory instruments or regulations which will flesh out the detail of the primary legislation, being the Regulation. 

These regulatory technical standards (“RTSs”) are still at a draft stage, although they were due to be finalised by the end of 2020. Notwithstanding this, the European Commission has announced that the application of SFDR is not conditional on the formal adoption of the RTSs.

The latest draft of the RTSs was published on 4 February 2021. The standards are proposed to come into application no earlier than 1 January 2022. On 25 February 2021 the ESAs issued a joint supervisory statement in which they recommended that national competent authorities, which would include the Pensions Authority, refer FMPs, including trustees, to the requirements of the draft RTSs in terms of the measures they take to implement SFDR. 

This is unsatisfactory, as the draft RTSs are still subject to approval by the European Commission and potential comment by the European Parliament or the European Council.

However, as matters stand, the draft RTSs are the best guide to the thinking of the ESAs on how SFDR should be implemented in practice.

Conclusion

For those Irish pension schemes which have already adopted an ESG focused strategy, and which have an interest in interrogating the sustainability of their investment strategy and their investment portfolio, SFDR is an opportunity to assess and validate that work within an EU certified framework. 

The element of public disclosure rather than member only disclosure may not sit well with many Irish trustees, but reflects a more general approach being adopted by European legislators to the pension sector.

For trustees who do not believe that an extensive focus on sustainability is the correct investment approach for their scheme, SFDR may be more of a challenge. However, the process of explaining why this is the case may in itself be important and beneficial for those trustees.

As with all European legislation there is the danger of an overly bureaucratic approach by the European supervisory authorities, and the final outcome of the RTSs remains to be seen.

Pending that, trustees should take advice on how to comply with their legal obligations under SFDR from 10 March 2021. 

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