November 18, 2020 Briefing

SMP Briefing:
Sustainability Disclosures – European Commission postpones publication of further guidance

With regard to the EU regulation on sustainability-related disclosures ("ESG Disclosure Regulation"), the issuance of further guidance has been postponed indefinitely. Given that the regulation will still become effective as of 10 March 2021, this raises questions on how VC or PE fund managers can adequately comply with the requirements set forth in the ESG Disclosure Regulation.

I. Background

Based on the UN 2030 Agenda on Sustainable Development with its 17 Sustainable Development Goals and following the adoption of the Paris Climate Agreement, the European Commission has released its Sustainable Finance Action Plan in 2018. The ESG Disclosure Regulation, published on 9 December 2019, is now part of the EU strategy to achieve the transition to a low‐carbon, more sustainable, resource‐efficient and circular economy. It requires financial market participants, including VC and PE fund managers, i.a. to disclose how they integrate sustainability risks in their investment processes. Furthermore, it sets forth a comply-or-explain provision: they must state whether they consider adverse sustainability impacts ('comply') or (why) not ('explain'). For further information please see our previous SMP Funds Briefing, dated 10 December 2019.

II. Regulatory technical standards on adverse sustainability impacts

As of 10 March 2021, the ESG Disclosure Regulation requires VC and PE fund managers taking the 'comply' route to publish and maintain on their websites a statement as to whether they consider principal adverse impacts of investment decisions on sustainability factors (i.e. environmental, social and employee matters, respect for human rights, anti‐corruption and anti‐bribery matters), a statement on due diligence policies with respect to those impacts, taking due account of their size, the nature and scale of their activities and the types of financial products they make available.

Alternatively, taking the 'explain' route, VC and PE fund managers may state that they do not consider adverse impacts of investment decisions on sustainability factors and give clear reasons why they do not do so, including, where relevant, information as to whether and when they intend to consider such adverse impacts.

While both, the 'comply' route as well as the 'explain' route, may be taken from a legal perspective, it is a common expectation that the market and investors will drive VC and PE fund managers towards compliance. Detailed requirements on the content and presentation of the disclosed information were to be specified by regulatory technical standards, developed by the European Supervisory Authorities ("ESAs") until 30 December 2020. A template with such regulatory technical standards had been included in the consultation process earlier this year. Such guidance usually facilitates further standardization as well as convergence across the financial sector, guaranteeing a harmonization of the European Single Market. However, the European Commission just recently informed the ESAs that the Covid-19 crisis as well as the resulting economic and market stress necessitated an extension of the public consultation on the draft regulatory standards. A new deadline has not been given. As a result, the ESG Disclosure Regulation will apply as of 10 March 2021 without further guidance being available on how to comply with the disclosure obligations being available.

III. Next steps?

The European Commission assumes that many financial market participants currently comply with non-financial reporting requirements as set forth in the Accounting Directive 2013/34/EU (implemented in the German Commercial Code (Handelsgesetzbuch)) and might consider using that information to meet their disclosure obligations. If PE funds already provide information on non-financial indicators pursuant to the Accounting Directive they may use this information. However, VC funds are typically not subject to those non-financial reporting requirements pursuant to the Accounting Directive, as they benefit from the facilitations for small companies under German commercial law. Therefore, VC fund managers typically are not in a position to build on such existing disclosures. The European Commission states that it is ready to coordinate with the ESAs and national competent authorities such as BaFin on disclosure approaches and that a number of trade associations in the financial services sector may assist their membership. It remains to be seen to what extent appropriate frameworks will be provided as a result thereof.

Unless appropriate frameworks are being provided, as of 10 March 2021 VC and PE fund managers can either choose the 'comply' route and come up with their own disclosure approaches. In doing so they may find some guidance in the template regulatory technical standards which had been published in the consultation process (although it appears such template may have been found to be too rigid and too extensive, and such criticism may have been one of the reasons the European Commission now calls off the publication of the regulatory technical standards by end of this year). Or they may voluntarily base their disclosures on the non-financial reporting requirements as set forth in the Accounting Directive.

Alternatively, VC and PE fund managers could choose the 'explain' route and state that they do not consider adverse impacts of investment decisions on sustainability factors due to the lack of regulatory guidance. For those who are generally willing to take the 'comply' route but do refrain from developing their own disclosure approach, it may be on option to also state that they intend to consider such adverse impacts once such guidance becomes available.