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Principal Adverse Impact (PAI) indicators in SFDR regulation

Celsia team
July 5, 2023
 min read

Principal Adverse Impacts (PAI) refer to any consequence arising from investment decisions or guidance that leads to an unfavorable impact on sustainability aspects, encompassing concerns regarding the environment, society, employees, human rights, the fight against corruption, and bribery-related issues. PAI indicators are then a set of environmental, social and governance indicators that aim to comprehensively represent how financial market participants take into account the sustainability risks of their investment decisions. Compliance with the reporting requirements regarding Principal Adverse Impacts, i.e. PAIs presents one of the most formidable responsibilities under the Sustainable Finance Disclosure Regulation (SFDR). 

PAIs are to be disclosed in the following ways: 

  1. Disclosure on an entity level (article 4 SFDR)
  2. Disclosure on a product level (article 7 SFDR)

In this blog, we discuss these in detail and how Celsia can help. 

PAI disclosure for entities

An annual PAI statement is provided by financial entities to address how they consider relevant PAIs stemming from their investment decisions regarding sustainability factors.

Financial market participants with 500 or more employees are obligated to publish their PAI statement for the specific financial year.

For other entities, a "comply or explain" requirement is applicable. Financial entities that considerPAIs of their investment decisions must explain in their PAI statement how they implement PAI considerations into their policies. Financial entities that do not consider PAIs need to provide a clear explanation for their decision and whether and when they intend to consider PAIs. The Annex I of the SFDR Regulatory Technical Standards offers a PAI statement template and a comprehensive overview of the mandatory and voluntary Principal Adverse Impact indicators formulated by the regulation. Financial entities should utilize this template to comply. The template comprises various sections, including descriptions of identified PAIs, PAI indicators, shareholder engagement policies, descriptions, and historical comparisons (with reference to relevant provisions of the SFDR RTS).

The PAI description within the statement should encompass the applied metrics, impacts, explanations, and actions taken or planned for each identified PAI indicator. The PAI indicators cover a wide range of environmental, social, and governance risks (also known as "ESG" risks). When formulating the PAI indicators, particular emphasis has been placed on climate and other environment-related concerns, as well as employee welfare, human rights, anti-corruption, and anti-bribery matters.

PAI disclosures for products

In addition to releasing the annual Principal Adverse Impact statement, financial market participants are required to ensure transparency regarding PAIs on a financial product level. It is important to note that this obligation does not extend to financial advisers.

For financial market participants with 500 or more employees, compliance is mandatory, while for others, the "comply or explain" principle may be applied.

If a particular financial product does not consider any PAI related to sustainability factors, the pre-contractual information must include a statement explicitly stating this, along with the reasons for such non-consideration. Conversely, if PAIs on sustainability factors are taken into account, the pre-contractual disclosure for each individual financial product must provide a comprehensive description of how this is done. In essence, the SFDR mandates that the pre-contractual information comprises:

  1. A clear and reasoned explanation regarding whether the financial product considers the PAI on sustainability factors, and if so, the approach taken.
  2. A statement indicating that the information pertaining to the PAI on sustainability factors will be included in a periodic or annual report.

PAIs in pre-contractual product disclosures

Regrettably, the SFDR and SFDR RTS do not provide detailed specifications regarding the publication of PAI information in pre-contractual documentation, other than requiring "a clear and reasoned explanation." The European Supervisory Authorities (ESAs) have, thus far, offered limited guidance by focusing on the fields provided in the templates outlined in the SFDR Delegated Regulation, which have been effective from 1 January 2023. ESMA has clarified that existing pre-contractual information disclosures for financial products must be revised to comply with the requirements specified in Article 7 of the SFDR for the Principal Adverse Impact indicators. 

The absence of delegated rules for product-level disclosure grants financial market participants significant discretion in tailoring PAI disclosures to their specific products, as opposed to entity-level disclosures. However, it is advisable to consider entity-level disclosures when crafting pre-contractual product disclosures to ensure alignment between the two and avoid any inconsistencies.

PAIs in periodic product disclosures

It is possible to use the PAI indicators to measure the environmental or social characteristics or the overall sustainable impact of a financial product, e.g. by showing improvements of the investments against those indicators over time. There are three possible uses three possible uses of the adverse impact indicators at financial product level:

1. Disclosure of  DNSH for sustainable investments under Article 2(17) of the SFDR: 

The use of PAI indicators is mandatory to demonstrate that an investment qualifies as a sustainable investment. The ESAs consider that using PAI indicators to fulfill  the  DNSH of SFDR does not require any PAI consideration at entity level pursuant to Article 4 (1)(a), 4(3) or 4(4) of the SFDR.

2. Disclosure of PAI considerations under Article 7 of the SFDR:

The disclosure of PAI consideration at product level is set out in Article 7 SFDR and is not further specified except for fields in the templates to provide the information required by that Article.

3. Measurement of the attainment of environmental or social characteristics and the sustainability: 

Sustainability indicators used to measure the  attainment  of  the environmental or social characteristics (for Article 8 SFDR financial products) or sustainable investment objective (e.g. the impact of the financial product  for  Article  9  SFDR products) may include PAI indicators. There is no direct link between sustainability indicators and PAI indicators. 

The ESAs clarify that the use of PAI indicators as sustainability indicators to measure the attainment of environmental or social characteristics or impact of  the sustainable investments does not require any prior PAI consideration at entity level pursuant to Article 4 SFDR or PAI consideration at product level pursuant to Article 7 SFDR.

How can Celsia help?

Celsia’s services include reporting on PAIs for financial market participants and we assist portfolio companies in gathering and reporting their PAI data. Our EU taxonomy scoring tool has a dedicated PAI section that guides portfolio companies through all mandatory PAI indicators, including a detailed guidance on how to approach the data collection. We also assist the funds and their portfolio companies with the selection of additional and voluntary PAI indicators to highlight their environmental and social performance in specific areas. Once the data is collected Celsia provides the funds with their aggregated PAI results.

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