Sustainability preferences refer to clients’ or potential clients’ choices as to whether and/or to what extent they wish to have their sustainability perspectives, which are outlined in the EU TR and EU SFDR, integrated into an investment product.
Clients can express their sustainability preference as one or more of the following options:
(a) A minimum proportion of environmentally sustainable investments as defined by the EU TR
(b) A minimum proportion of sustainable investments as defined by the EU SFDR
(c) The consideration of Principal Adverse Impacts (PAIs) on sustainability factors, from a qualitative and/or quantitative perspective
We further describe each of these choices in detail:
(a) Environmentally sustainable investment as defined by the EU TR
According to the EU TR, a sustainable investment is an investment in an economic activity that aligns to a limited number of recognised sustainable objectives and activities, and is subject to a technical screening criteria.
The EU TR specifies six EU environmental objectives:
1. Climate change mitigation*
2. Climate change adaptation*
3. Sustainable use and protection of water and marine resources**
4. Transition to a circular economy**
5. Pollution prevention and control**
6. Protection and restoration of biodiversity and ecosystems**
*Level 2 standards confirmed as of 9 December 2021.
**Level 2 standards under review.2
Broadly, an economic activity may be considered “environmentally sustainable” under the EU TR if it meets the following conditions (known as the technical screening criteria):
1. Makes a substantial contribution to at least one of the EU’s six environmental objectives
2. Does not cause significant harm to any of the other EU environmental objectives to which it is not aligned
3. Meets prescribed minimum ESG safeguards
4. Meets the technical screening criteria set out by the EU TR
(b) Sustainable investments defined by the EU SFDR
The EU SFDR definition of a sustainable investment is broader and accommodates investments outside the EU TR definition subject to base conditions being met. These include:
1. A measurable contribution of an environmental and/or social objective
- From an environmental perspective, this could include key resource efficiency indicators on the use of energy, renewable energy, raw materials, water and land; or similar measurements of the production of waste or greenhouse gas emissions.
- From a social perspective this could include an investment that contributes to tackling inequality or that fosters social cohesion, social integration and labour relations; it could also include an investment in human capital or economically or socially disadvantaged communities.
2. No significant harm to any other environmental and/or social objective
3. Good governance practices at investee companies, particularly with respect to sound management structures, employee relations, remuneration of staff and tax compliance
Importantly, the MiFID definition does not recognise those investments that only have environmental and/or social characteristics as sustainable investments.
(c) Consideration of PAIs
PAIs look at the material effect investments can have on a wide range of environmental and social considerations, regardless of any financial impact. For example, an investment in a commodity producer may be profitable from a purely financial standpoint, but PAIs might include an extraction process that is harmful to the environment and poor safety standards that put workers at risk.
The EU SFDR does not provide one comprehensive definition for PAIs but instead identifies specific Principal Adverse Impact Indicators (PAIIs) and their corresponding PAIs, which are based on actual metrics for measurement. Some of the PAIIs and PAIs are grouped together in related categories. For example, “Greenhouse gas emissions” is a broad PAII grouping for six PAIIs, each with their own corresponding PAI. Other categories, such as “Emissions to water” are not further divided (see example).
When considering the potential for PAI integration with clients, firms may discuss an approach based on the broader categories rather than each separate PAII.
Example of considering PAI in an investment