In this series of articles, we zoom in on the Level 2 rules of the Sustainable Finance Disclosure Regulation (SFDR). We start with an issue that is also relevant to the implementation of the Level 1 text: the do no significant harm (DNSH) principle.
The do no significant harm principle is part of the SFDR’s definition of the term ‘sustainable investment’. Indeed, the SFDR defines a sustainable investment as:
“an investment in an economic activity that contributes to the achievement of an environmental objective (…) or to the achievement of a social objective (…) provided that these investments do not seriously compromise those objectives and the investee companies follow good governance practices.”
From this definition, we conclude that an investment can only be a sustainable investment if it achieves its sustainable objective without causing significant harm to other environmental or social objectives. To illustrate, an investment in the construction of a wind farm (which would help reduce CO2 emissions) is not sustainable if the construction is at the expense of a protected nature reserve.
Why is the DNSH principle important for the implementation of the SFDR? Just now, we saw that the DNSH principle is part of the concept of ‘sustainable investment’. That concept is relevant for the qualification of the financial products you offer.
Under the SFDR, you have to classify all your products according to their sustainability level. Is the product grey, light green, or dark green?
A dark green product is defined in the SFDR as one whose objective is ‘sustainable investment’. Since the DNSH principle is a component of the SRI concept, when investing for dark green products, your company should check whether the DNSH principle is met.
Incidentally, for light green products, partial investments can also be made in sustainable investments. If this is the case, you should therefore determine for that part too whether those investments meet the DNSH principle before you can speak of ‘sustainable investments’.
Does your company offer light green or dark green products? If so, you are probably now wondering how exactly to test whether a (potential) investment complies with the DNSH principle.
The Level 1 text of the SFDR does not specify this. Therefore, it seemed at first that companies were allowed to figure out for themselves how they would interpret the principle. That later turned out not to be the case after all. The ESAs were given the task – in the Level 2 regulations – of providing clarity on the DNSH principle.
This led to the following. To satisfy the DNSH principle (one of the conditions to qualify as a ‘sustainable investment’) from the level 2 text, it must state:
The first point implies that, when making the sustainable investment, the company should indicate how it takes into account any adverse ESG implications of the investment. For example, is the investment related to high greenhouse gas emissions, deforestation, or workplace discrimination? Then it cannot be called a ‘sustainable investment’. But what exactly is meant by taking negative impacts into account? Is it enough that these negative impacts are identified, if nothing is then done about them? No, it certainly is not. After all, it follows from the DNSH principle that the investment should not significantly harm other environmental and/or social objectives.
The second point implies that SRI should be in line with the OECD Guidelines for Multinational Enterprises and UN principles on business and human rights. For example, the principles and rights cited in the International Labour Organisation (ILO) Declaration on Fundamental Principles and Rights at Work, and the principles in the International Bill of Human Rights.
It seems that the ESAs consider that interpretation of the DNSH principle can be given by explaining how you have met the first and second points and that in this way, the SRI does not cause significant harm to other environmental and/or social objectives.
Do you have any questions following the above information? Could you use support in mapping out and implementing ESG regulations, such as the SFDR? We would be happy to tell you more about ESG regulations for the financial sector, and their impact on your company. Read more about our help with SFDR compliance, or follow our SFDR Awareness e-learning.
