If you are interested in understanding more comprehensively the reasons for us to typically adopt such a stance, please consult the Article below in full, or in case you would like to briefly get an overview of the pros and cons of adopting either decision, please consult Pros and cons of compliance on entity- and on product level.

One of the main requirements stemming from the Sustainable Finance Disclosure Regulation (SFDR) is that of incorporating Principal Adverse Impact (PAI) Indicators into the investment decision-making process. You are required to make a decision on whether you would like to opt for complying with the incorporation exercise, and thus incorporate PAIs into your investment decision-making process, or would rather opt for explaining the reasons for not considering the PAIs.

The requirement of incorporating the PAI Indicators can be further divided into two broad categories: i) an entity-level PAI requirement, and its ii) product-level PAI counterpart.

While entity-level disclosures apply to all legal entities that fall under the control of your firm's manager, product-level disclosures apply to a financial product marketed by the firm on the 10th of March 2021 (i.e., entry into force of Level 1 SFDR requirements), and is done separately for each individual product.

Article 4 SFDR codifies the entity-level PAI requirement:

"Financial market participants shall publish and maintain on their websites:

(a) where they consider principal adverse impacts of investment decisions on sustainability factors, 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; or

(b) where they do not consider adverse impacts of investment decisions on sustainability factors, clear reasons for why they do not do so, including, where relevant, information as to whether and when they intend to consider such adverse impacts".

Article 7 SFDR mirrors the requirement for product-level disclosure of PAI, requiring disclosure starting 30 December 2022.

On 25 May 2022, the Commission published a Q&A Communication in response to ESMA's questions on the SFDR's and the EU Taxonomy's interpretation. In this Q&A, the Commission clarifies that an FMPs who have decided to explain non-compliance with the PAIs on entity-level, are still allowed to launch and label products seeking reduction of negative externalities caused by the investments of the product, aka PAI-compliant products. It is therefore possible that, after opting out of the PAI compliance on entity level, you decide to opt-in for compliance on product level.

It is however important to keep in mind that setting in place the necessary processes for a product-level PAI disclosures largely mirror those required at entity level, and once the latter is set up the former becomes much simpler to implement. Furthermore, complying on entity level gives credibility to your commitments of incorporating sustainability metrics into your investment strategy and becoming an impact-focused financial firm.

In a newly published Clarification by the ESAs, a new use of the PAIs was clarified. An asset manager wanting to launch a 'sustainable' product categorised as a 'dark-green/Article 9 fund' is required to use the PAI indicators to prove that the investment qualifies as 'sustainable'. This is to be done by demonstrating that ' do no significant harm' ('DNSH') to the remaining objectives was caused during the performance of the activity, to be demonstrated through PAI indicators selected as relevant for demonstrating DNSH with each of the objectives.

Furthermore, you are allowed to, though not required to, use PAI indicators as sustainability indicators to measure the attainment of environmental or social characteristics of a light-green/Article 8 fund.

Both of these two uses of the PAI framework are separate from the decisions to consider the PAI indicators on entity- and product-level, and serve as instruments to facilitate proving that a sustainable investment or sustainable characteristics are sought by a product. They do not require the consideration of the full spectrum of mandatory indicators and selecting two additional voluntary indicators, but allow you to choose which indicators are relevant for proving the DNSH and contribution of the objectives/proving the sustainable characteristics of the fund.

The tables below list some of the main advantages and disadvantages of opting for either the 'comply' or 'explain' option in addressing the requirements of incorporating PAI indicators.

If you decide to comply with the consideration of the PAIs, you will need to review your firm's current consideration of sustainability factors. A decision will need to be made to implement or update policies in place concerning integration of sustainability factors, and make the required alterations to the processes and mechanisms to gather the required sustainability data and reflect the policies.

Thus, prior to PAI statement disclosure, you will need to set processes in place monitor 14 mandatory non-financial, ESG-related KPIs, and need to decide upon including two additional voluntary indicators (one social and one environmental PAI indicator).

The first referencing period for the monitoring of those indicators begins on the 1st of January 2022 and ends on the 31st of December 2022, and the disclosure date for that period is the 30 June 2023.

For firms choosing to opt-in for compliance after 1 January 2023 will have their first reference period set as beginning from the opt-in date and ending on the 31st of December of that year, having to report on the monitoring by the 30th of June of the following year.

Once the sustainability factors have been successfully incorporated into the decision-making process, we can draft the required disclosures by the SFDR for your website.

In this statement, you are required to describe processes you have set in place to identify and prioritise your PAIs as well as policies in place to incorporate those. The final two chapters of the statement outline brief summaries of engagement policies and elaborate on your firm's compliance with internationally recognised standards.

If you decide to explain reasons for not considering the PAIs, you have to publish an Express Negative Statement on your Website, in a separate section called 'No consideration of sustainability adverse impacts'.

The disclosure must begin with a prominent statement clarifying that you do not consider adverse impacts of your investment decisions on sustainability factors. The explanation must also include a clarification on the processes you have in place to review such decision, and reasons for not currently considering the PAIs.

Deciding to not comply with incorporating the PAIs into the investment process will preclude you from being able to market yourself as an impact-focused firm, and from mentioning sustainability as forming part of your investment strategy.

Furthermore, opting out of compliance with the PAI indicators precludes you from labelling one of your existing funds/launching a fund categorised as Article 8 (e.g., light-green product, namely a financial product with sustainable characteristics) or Article 9 (i.e., dark-green product, namely a financial product with sustainable objective) product.