Principle of do no significant harm (DNSH)
- Category: Taxonomy
The concept of avoiding significant harm - the principle of 'do no significant harm’ (DNSH) - is expressed across both:
- the SFDR (Article 2(17)) and
- the Taxonomy Regulation (Article 17).
ESA’s Final report of 22 October 2021 on taxonomy-related product disclosure RTS with regard to the content and presentation of disclosures pursuant to Article 8(4), 9(6) and 11(5) of Regulation (EU) 2019/2088 reads:
“The EU taxonomy sets out a “do not significant harm” principle by which taxonomy-aligned investments should not significantly harm EU taxonomy objectives and is accompanied by specific EU criteria. The “do no significant harm” principle applies only to those investments underlying the financial product that take into account the EU criteria for environmentally sustainable economic activities.The investments underlying the remaining portion of this financial product do not take into account the EU criteria for environmentally sustainable economic activities. Any other sustainable investments must also not significantly harm any environmental or social objectives" (JC 2021 50, p. 36).
DNSH principle is to be specified through the European Commissions' delegated acts. Article 2a of SFDR grants the European Supervisory Authorities (the ESAs) the power to develop draft regulatory technical standards to specify the details of the content and presentation of the information in relation to the principle of ‘do no significant harm’ (see ESAs Final Report of 2 February 2021 on draft Regulatory Technical Standards with regard to the content, methodologies and presentation of disclosures pursuant to Article 2a(3), Article 4(6) and (7), Article 8(3), Article 9(5), Article 10(2) and Article 11(4) of Regulation (EU) 2019/2088, JC 2021 03). Further, the power is delegated to the European Commission to supplement the SFDR by adopting the relevant regulatory technical standards. This mandate has been fulfilled on 6 April 2022 when the European Commission adopted Commission Delegated Regulation supplementing Regulation (EU) 2019/2088 of the European Parliament and of the Council with regard to regulatory technical standards specifying the details of the content and presentation of the information in relation to the principle of ‘do no significant harm’, specifying the content, methodologies and presentation of information in relation to sustainability indicators and adverse sustainability impacts, and the content and presentation of the information in relation to the promotion of environmental or social characteristics and sustainable investment objectives in pre-contractual documents, on websites and in periodic reports.
Chapter III of the said Regulation lays down requirements on compliance with the ‘do not significant harm’ principle in relation to the Principal Adverse Sustainability Impacts (PAI) in Annex I. Definitions of significant harm are established for each environmental objective. For example, as regards climate change mitigation, an activity is deemed to cause significant harm where it leads to significant greenhouse gas emissions, on a lifecycle basis.
DNSH principle is conceptually related to Principal Adverse Sustainability Impacts. Recital 22 of the said Commission Delegated Regulation of 6 April 2022 explains:
“The principle of ‘do not significant harm’ is linked to the disclosures of principal adverse impacts of investment decisions on sustainability factors. For that reason, financial product disclosures about the ‘do not significant harm’ principle should explain how the indicators for adverse impacts have been taken into account”.
The “does not significantly harm” principle of the Taxonomy Regulation focuses on the six environmental objectives recognized by the Taxonomy Regulation. The “principal adverse impact indicators” of the SFDR have, however, a broader scope, ranging from environmental indicators to social and employee, respect for human rights, anti-corruption, and anti-bribery matters.
According to the said Recital 22:
- the ‘do not significant harm’ principle is particularly important for dark green products as compliance with that principle is a necessary criterion to assess whether an investment delivers the sustainable investment objective;
- that principle is, however, also relevant for light green products where those financial products make sustainable investments, as financial market participants should disclose the proportion of sustainable investments made;
- financial market participants that make available light green products which partly make sustainable investments or dark green products should thus provide information relating to the ‘do not significant harm’ principle.
It is also stated that, as the above disclosures are closely linked to the Taxonomy Regulation, it is appropriate to require additional information on the alignment of the investments with the minimum safeguards set out in that Regulation.
PAI considerations versus the DNSH disclosures
The difference between the PAI consideration and the DNSH disclosures have been explained in greater detail in the document of European Supervisory Authorities (ESAs) of 2 June 2022 ‘Clarifications on the ESAs’ draft RTS under SFDR” (JC 2022 23). The significant attention to this topics is reasoned by the fact that both require the use of the same adverse impact indicators in Annex I of the draft RTS.
The ESAs’ draft RTS set out disclosures for financial products’ sustainable investments’ (as referred to in Article 2(17) SFDR) DNSH requirements for pre-contractual disclosures, for website disclosures and for periodic disclosures. The disclosures require an explanation of how the sustainable investment does not significantly harm any sustainable investment objective with reference to “how the indicators for adverse impacts in Table 1 of Annex I, and any relevant indicators in Tables 2 and 3 of Annex I, are taken into account”.
This should not be mistaken with the disclosures required by Article 4 and 7 SFDR which contain references to how the financial market participant or financial product considers the principal adverse impacts of its investments. For disclosures under Article 4 SFDR, that consideration is done by the publication of a statement on the principal adverse impacts of investment decisions on sustainability factors with reference to the indicators in Annex I.
For the financial product’s DNSH disclosures, the ESAs’ did not set out any additional criteria for the taking into account of the adverse impact indicators in Annex I. Based on the definition of sustainable investment, the ESAs consider that financial market participants can determine whether the indicators have been respected for the purpose of disclosing that the investment has not significantly harmed any environmental or social objective. One factor worth considering when making that determination is to compare, where feasible, the impacts with similar metrics in the Climate Delegated Act and the Complementary Climate Delegated Act.
For the avoidance of doubt, there is no direct link between the two types of disclosures, which apply independently. A financial product making sustainable investments must make DNSH disclosures, whereas the PAI disclosures at financial product level referred to in Article 7 SFDR apply separately under that Article.
The ESAs acknowledge that their final reports did not specify exactly how the PAI indicators should be used for the purpose of the DNSH disclosures for sustainable investments in the RTS or the financial product disclosures. However, best practice could be to disclose DNSH for sustainable investment by extracting the indicators from Table 1 of Annex I, and any additional relevant indicators from Table 2 and 3 of Annex I, and show the impact of the sustainable investments against those indicators, proving through appropriate values (e.g. where feasible in compliance with the Climate Delegated Act12 and the Complementary Climate Delegated Act) that the sustainable investments do not significantly harm any environmental or social objectives.
DNSH disclosures of the SFDR versus the DNSH requirements of the Taxonomy Regulation
Regulatory clarifications how the DNSH disclosures of the SFDR interact with the DNSH requirements of the Taxonomy Regulation have been included in the ESAs Clarifications of 2 June 2022 on the ESAs’ draft RTS under SFDR (JC 2022 23).
The DNSH principle under Taxonomy Regulation is not applied in the same way as it is under Article 2(17) SFDR. When assessing whether an economic activity qualifies as environmentally sustainable, the TR sets out detailed DNSH activity level criteria under Article 17 TR and in technical screening criteria in relevant Delegated Acts. In contrast, the SFDR sets out this principle for the purpose of assessing at the level of the investment which may qualify as sustainable. In that respect, it means that to qualify as a sustainable investment in the meaning of SFDR, an investment in a taxonomy-aligned economic activity must also respect the 'do not significantly harm' principle as set out in Article 2(17) SFDR. While Article 2(17) SFDR itself does not provide under Level 1 specific criteria that need to be assessed, the empowerment to the ESAs in Article 2a SFDR, and the SFDR draft RTS contained a requirement to demonstrate DNSH by reference to the indicators for principle adverse impact in Annex I.
The RTS included an additional requirement to the DNSH provisions. In addition to disclosing how the financial market participant has taken into account the indicators for adverse impact in Annex I, the DNSH reporting should also show whether the investments are aligned with the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights, including the principles and rights set out in the eight fundamental conventions identified in the Declaration of the International Labour Organisation on Fundamental Principles and Rights at Work and the International Bill of Human Rights. The objective of this provision is to bring the DNSH disclosures under SFDR in line with the minimum safeguards in Article 18 Taxonomy Regulation.