Sustainable Finance Disclosures Regulation (SFDR) is one of the three pillars of the European Union’s Action Plan on Sustainable Finance. Our first blog on SFDR provided an overview of the regulation (read here), and the classification of funds based on their sustainability objective (Article 6, 8 and 9 Funds). In this blog, we explore some of the data requirements of SFDR which are described as Principal Adverse Impacts (PAI) Indicators.
Double Materiality in SFDR
The concept of “Double Materiality” is a core element of the EU’s Corporate Sustainability Reporting Directive (CSRD). In an earlier article, we examined how EU firms have to report not only the “Outside-In” impact of external environment on the financial performance of a firm, but also report the “Inside-Out” perspective, which is the impact of the firm on all stakeholders (read here).
The SFDR mandates disclosures by Financial Market Participants (FMP) and Financial Adviser (FAs) based on “Double Materiality” principles. Financial Materiality is captured in the “Sustainability risks” disclosures and the Impact Materiality is captured in the “Principal Adverse Impacts (PAI) on sustainability factors”.
“Sustainability Risks” are the issues related to sustainability (climate change, social inequities, etc) that can have a negative impact on the economic value of an investment.
“Principal Adverse Impacts (PAI) on sustainability factors” are the negative impacts caused by a firm or an asset on the environment and society.
These PAI Indicators are used both in SFDR(to classify funds under Articles 8 and 9) and in MiFID II/IDD in aligning the sustainable preferences of clients with suitable sustainable products(click here for details on MiFID II/IDD).
The submission of the PAI statement is expected by June 2023, based on 2022 data.
Principal Adverse Impacts (PAI) Indicators
The delegated regulation on SFDR(access here) requires mandatory reporting of PAI indicators, which are divided into a “core set of universal mandatory indicators” and “additional opt-in indicators”. The applicability of PAIs differ between investments for
- Investee companies
- Sovereigns and Supranationals
- Real estate assets.
There are 18 core indicators and 46 additional indicators across the three types of entities. While all 18 core indicators have to be mandatorily reported, fund managers have to report on at least one additional indicator each in environmental and social issues for investee companies, and one additional indicator for real estate assets. They can voluntarily disclose more indicators if they deem them to be relevant.
The Annex 1(click here) of the SFDR provides extensive details of the Principal Adverse Impacts (PAI) indicators, some of which are summarized below.
| Summary for Core Indicators | |||
| Type of entity | Environmental Issues | Social Issues | Total |
| Investee Companies | 9 | 5 | 14 |
| Sovereigns and Supranationals | 1 | 1 | 2 |
| Real estate assets | 2 | 0 | 2 |
| Total | 12 | 6 | 18 |
| Summary for Additional Indicators | |||
| Type of entity | Environmental Issues | Social Issues | Total |
| Investee Companies | 16 | 17 | 33 |
| Sovereigns and Supranationals | 1 | 7 | 8 |
| Real estate assets | 5 | 0 | 5 |
| Total | 22 | 24 | 46 |
The full set of PAI indicators are given in the two tables at the end of this article.
Greenhouse Gas Emissions and Principal Adverse Impacts (PAI)
Reporting on Scope 1, 2 and 3 emissions is an important aspect of Principal Adverse Impacts.(Click here to read more about Scope emissions). In fact, the emissions data reported by corporates is used in 3 of the core indicators under the Environmental Pillar of PAI. These three sustainability indicators are GHG Emissions, Carbon Footprint, and GHG Intensity of Investee Companies.
Conclusion
The Principal Adverse Impacts (PAI) Indicators are used both Financial Market Participants(FMP) and Financial Advisers(FA) in order to comply with SFDR and MiFID II/IDD regulations respectively. Data challenges are expected and hence it is important for the FMPs and FAs to proactive gather data.
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Table 1 – Core Indicators
| Core Indicators- Investee Companies | |||||
| Environmental | Social and Employees, Respect for Human Rights, Anti-corruption and Anti-bribery | ||||
| Topic | Sustainability Indicator | Topic | Sustainability Indicator | ||
| Greenhouse gas emissions | 1 | GHG Emissions | Social and employee matters | 1 | Violations of UN Global Compact principles and Organization for Economic Cooperation and Development (OECD) Guidelines for Multinational Enterprises |
| 2 | Carbon footprint | 2 | Lack of processes and compliance mechanisms to monitor compliance with UN Global Compact principles and OECD Guidelines for Multinational Enterprises | ||
| 3 | GHG Intensity of Investee companies | 3 | Unadjusted gender pay gap | ||
| 4 | Exposure to companies active in the fossil fuel sector | 4 | Board gender diversity | ||
| 5 | Share of non-renewable energy consumption and production |
5 | Exposure to controversial weapons (anti-personnel mines, cluster munitions, chemical weapons and biological weapons) | ||
| 6 | Energy consumption intensity per high impact climate sector | ||||
| Biodiversity | 7 | Activities negatively affecting biodiversity-sensitive areas | |||
| Water | 8 | Emissions to water | |||
| Waste | 9 | Hazardous waste and radioactive waste ratio | |||
| Core Indicators-Sovereigns and Supranationals | |||||
| Environmental | 1 | GHG intensity | Social | 1 | Investee countries subject to social violations |
| Core Indicators-Real estate assets | |||||
| Fossil Fuels | 1 | Exposure to fossil fuels through real estate assets |
None | ||
| Energy Efficiency | 2 | Exposure to energy-inefficient real estate assets | None | ||
Table 2 – Additional Indicators
| Environmental | Social and Employees, Respect for Human Rights, Anti-corruption and Anti-bribery | ||||
| Emissions | 1 | Emissions of inorganic pollutants | Social and employee matters | 1 | Investments in companies without workplace accident prevention policies |
| 2 | Emissions of air pollutants | 2 | Rate of accidents | ||
| 3 | Emissions of ozone-depleting substances | 3 | Number of days lost to injuries, accidents, fatalities or illness | ||
| 4 | Investments in companies without carbon emission reduction initiatives | 4 | Lack of a supplier code of conduct | ||
| Energy performance | 5 | Breakdown of energy consumption by type of non-renewable sources of energy | 5 | Lack of grievance/complaints handling mechanism related to employee matters | |
| Water, waste and material emissions | 6 | Water usage and recycling | 6 | Insufficient whistleblower protection | |
| 7 | Investments in companies without water management policies | 7 | Incidents of discrimination | ||
| 8 | Exposure to areas of high water stress | 8 | Excessive CEO pay ratio | ||
| 9 | Investments in companies producing chemicals | Human Rights | 9 | Lack of a human rights policy | |
| 10 | Land degradation, desertification, soil sealing | 10 | Lack of due diligence | ||
| 11 | Investments in companies without sustainable land/agriculture practices | 11 | Lack of processes and measures for preventing trafficking in human beings | ||
| 12 | Investments in companies without sustainable oceans/seas practices | 12 | Operations and suppliers at significant risk of incidents of child labour | ||
| 13 | Non -recycled waste ratio | 13 | Operations and suppliers at significant risk of incidents of forced or compulsory labour | ||
| 14 | Natural species and protected areas | 14 | Number of identified cases of severe human rights issues and incidents | ||
| 15 | Deforestation | Anti-corruption and anti-bribery | 15 | Lack of anti-corruption and anti-bribery policies | |
| Green securities | 16 | Share of securities not issued under Union legislation on environmentally sustainable bonds | 16 | . Cases of insufficient action taken to address breaches of standards of anti-corruption and anti-bribery |
|
| 17 | Number of convictions and amount of fines for violation of anti-corruption and antibribery laws | ||||
| Additional Indicators – Sovereigns and Supranationals | |||||
| Green securities | 1 | Share of bonds not issued under Union legislation on environmentally sustainable bonds | Social | 1 | Average income inequality score |
| 2 | Average freedom of expression score | ||||
| Human rights | 3 | Average human rights performance | |||
| Governance | 4 | Average corruption score | |||
| 5 | Non -cooperative tax jurisdictions | ||||
| 6 | Average political stability score | ||||
| 7 | Average rule of law score | ||||
| Additional Indicators – Real estate assets | |||||
| Greenhouse gas emissions | 1 | GHG emissions | |||
| Energy consumption | 2 | Energy consumption intensity | |||
| Waste | 3 | Waste production in operations | |||
| Resource consumption | 4 | Raw materials consumption for new construction and major renovations | |||
| Biodiversity | 5 | Land artificialisation | |||
