The requirement to publish the Principal Adverse Impact (PAI) statement became mandatory in January 2023 for financial market participants with 500 or more employees. Despite this, a PwC study revealed that only 21.6% of management companies have complied by making their PAI statements publicly accessible [1]. This falls short of the Sustainable Finance Disclosure Regulation (SFDR) Level II technical standards. Although some PAI statements from management companies contained positive examples, the majority were incomplete, lacked comprehensive quantitative and qualitative data, or were entirely blank. Therefore, it is urgent to gain a clear understanding of how PAI is disclosed, ensuring full compliance with regulatory standards and enhancing transparency in sustainable finance. 

In this article, we will closely examine how Principal Adverse Impacts (PAIs) are disclosed at two distinct levels. We will begin by reviewing the official document published by the European Parliament on the Sustainable Finance Disclosure Regulation (SFDR), and then delve into case studies of Amundi and Blackrock. 

What Is PAI? 

PAI indicators serve as a critical measure of the negative effects that investment decisions may have on sustainability factors. The PAI statement employs a standardized template to monitor essential metrics for each indicator identified, providing a clear picture to both current and potential investors regarding the impacts of their decisions on crucial environmental and social issues. This standardized reporting framework aims to address and mitigate greenwashing concerns, assuring stakeholders that so-called “sustainable” portfolios are genuinely meeting their objectives. 

PAI statements must be published by financial market participants, particularly those with over 500 employees, in adherence to regulatory requirements. These disclosures should be made annually, with the data collected and reported meticulously to align with the Sustainable Finance Disclosure Regulation (SFDR) guidelines. By providing consistent and transparent information, PAI statements help promote accountability and trust in sustainable investing, ensuring that market participants can make informed decisions that truly advance the cause of sustainability. 

The Sustainable Finance Disclosure Regulation (SFDR) mandates two levels of disclosures: entity level and product level. At the entity level, financial market participants are required to disclose information about their overall sustainability policies and potential adverse impacts on sustainability factors. At the product level, disclosures focus on the sustainability characteristics and objectives of specific financial products, offering detailed insights into how individual investment products contribute to or mitigate adverse sustainability impacts. This dual level of disclosure ensures comprehensive transparency, enabling stakeholders to assess both the macro and micro aspects of sustainable finance practices. 

How To Disclose PAI At Each Level 

As we are aware, the Sustainable Finance Disclosure Regulation (SFDR) mandates two levels of disclosures: entity level and product level. To properly disclose Principal Adverse Impact (PAI) statements, firms must adhere to both levels. According to Regulation (EU) 2019/2088, here is the process for firms to disclose PAI statements at each level: 

Entity-Level Disclosure 

Entity-level disclosure focuses on how financial market participants (FMPs) integrate sustainability risks and principal adverse impacts in their investment decision-making processes. Here are key points to cover: 

Integration of Sustainability Risks: Firms must describe how they integrate sustainability risks into their investment decisions and the likely impacts of these risks on the financial returns of the products they manage. 

Statement on Due Diligence Policies: Firms are required to provide a statement on their due diligence policies with respect to the principal adverse impacts of their investment decisions on sustainability factors. This includes: 

• Identification and Prioritization: How they identify and prioritize adverse sustainability impacts and indicators. 

• Actions Taken: The measures taken to address the principal adverse impacts. 

• Engagement Policies: How they engage with the companies they invest in to address these impacts. 

• References to International Standards: Adherence to responsible business conduct codes and internationally recognized standards for due diligence and reporting. 

Transparency on Adverse Sustainability Impacts: Firms must publish and maintain on their websites information about their policies on the identification and prioritization of principal adverse sustainability impacts and indicators. 

Product-Level Disclosure 

At the product level, the SFDR requires detailed disclosures about how sustainability risks are integrated into specific financial products. Here’s what to include: 

Pre-Contractual Disclosures: Information must be included in pre-contractual documents about how sustainability risks are integrated into investment decisions and the likely impact of sustainability risks on the returns of the financial products. 

Periodic Reporting: Firms need to provide periodic reports detailing: 

• How ESG Characteristics Are Met: Explanation of how the product’s environmental or social characteristics are met. 

• Sustainability Indicators: Information on the performance of the product against the sustainability indicators used. 

Transparency on Adverse Impacts: For products that promote environmental or social characteristics or have a sustainable investment objective, disclosures must include: 

• Adverse Impact Consideration: How the product considers principal adverse impacts on sustainability factors. 

• Product Alignment with Sustainability Goals: Detailed explanation of how the product aligns with sustainability objectives, including metrics and targets. 

Case Studies: Principal Adverse Impact (PAI) Disclosure

Amundi Asset Management

Entity-Level Disclosure: Amundi, a leading asset management firm, provides a comprehensive PAI statement at the entity level. They detail how they integrate sustainability risks and adverse impacts into their investment processes. Amundi’s approach includes: 

• Identification and Prioritization: Amundi uses ESG scores and exclusion policies for certain sectors, such as tobacco and controversial weapons, to identify and prioritize adverse sustainability impacts. 

• Actions Taken: The company describes specific measures to mitigate these impacts, including active ownership and engagement with investee companies. 

• Transparency: Amundi publishes detailed reports on their website, outlining their policies and procedures for managing sustainability risks. 

Product-Level Disclosure: Amundi’s ESG-focused funds, such as the Amundi Funds Global Ecology ESG, include specific disclosures about PAI considerations: 

• Environmental Metrics: The fund documents highlight metrics such as carbon footprint, water usage, and waste management. 

• Engagement Processes: Detailed descriptions of how the fund engages with companies to improve their sustainability practices are provided. 

• Performance Indicators: The fund reports on its performance against key sustainability indicators [3].

BlackRock

Entity-Level Disclosure: BlackRock provides a robust PAI statement that emphasizes the integration of sustainability risks across its investment processes. Their entity-level disclosure includes: 

• Identification and Prioritization: BlackRock outlines its framework for identifying and assessing adverse impacts on sustainability, focusing on areas like climate-related risks and governance issues. 

• Actions Taken: The firm details its active engagement policies, including voting practices and direct dialogue with investee companies to address adverse impacts. 

• Transparency: BlackRock’s annual stewardship report includes comprehensive information on their PAI policies and procedures. 

Product-Level Disclosure: BlackRock’s iShares ESG Aware MSCI USA ETF provides detailed information on PAI considerations at the product level: 

• Selection Criteria: The ETF discloses its methodology for selecting companies with strong ESG performance. 

• Performance Metrics: It includes metrics for tracking environmental and social impacts, such as greenhouse gas emissions and diversity indicators. 

• Reporting: Regular updates on the ETF’s sustainability performance and how it aligns with its investment objectives are provided. 

By examining these examples, other firms can learn best practices for PAI disclosures and improve their own sustainability reporting, ensuring compliance with regulatory standards and enhancing transparency in sustainable finance. 

Challenges in Disclosing Principal Adverse Impacts (PAIs) and Solutions 

A recent study revealed that only 21.6% of management companies have issued publicly accessible Principal Adverse Impact (PAI) statements, falling short of the SFDR Level II standards. This low compliance rate can be attributed to several key challenges: 

1. Lack of Data and Expertise: Many firms struggle with the availability of reliable data and the technical expertise required to assess and report PAI metrics effectively. Only 35% of companies surveyed feel they have sufficient data to meet SFDR requirements.
2. Complexity of Regulations: The complexity of SFDR regulations and the evolving nature of sustainability standards create significant hurdles. Over 40% of firms find the regulatory landscape confusing and challenging to navigate.
3. Resource Constraints: Smaller firms, in particular, lack the resources to implement comprehensive PAI reporting systems. About 30% of firms cited resource limitations as a major barrier.

Solutions to Overcome These Challenges: 

• Enhancing Data Capabilities: Investing in advanced data analytics and partnering with ESG data providers can help firms enhance data accuracy and reliability. 

• Training and Development: Offering training programs and hiring ESG specialists can bridge the expertise gap, making it easier to comply with SFDR requirements. 

• Leveraging Technology: Adopting technology solutions such as automated reporting tools and ESG platforms can streamline the PAI disclosure process, reducing the burden on firms. 

By addressing these challenges head-on, firms can improve their PAI disclosures, ensuring compliance with SFDR regulations and enhancing their sustainability credentials [2]. 

Conclusion 

PAI disclosure is a critical aspect of sustainable finance, providing transparency and accountability to investors. Firms that prioritize PAI reporting can not only meet regulatory requirements but also strengthen their sustainability practices and attract socially responsible investors. So, it is essential for companies to proactively integrate sustainability risks into their investment processes and provide comprehensive disclosures of their adverse impacts to promote transparency in sustainable finance.  

 

Sources: 

[1] https://www.pwc.lu/en/sustainable-finance/mind-the-gap.html 

[2] https://future.portfolio-adviser.com/less-than-quarter-of-companies-have-issued-sfdr-pai-statements/ 

[3] 2023 Sustainable Finance Disclosure Statement Amundi