ESG – The Principal Adverse Sustainability Impacts Regime

Our partner Mika Lehtimäki discusses in the post the revised, more detailed principal adverse sustainability impacts regime of the EU that will require extensive organisational resources and analysis from financial firms in 2022. The post is directed especially to asset management firms.

Financial firms and larger non-financial companies will face a number of new requirements concerning European Union and national environmental and sustainability legislation in 2022. In this post, we discuss one important aspect of the EU ESG legislation, which will require prompt and extensive action from corporates as a whole. We discuss here the so-called ’Principal Adverse Sustainability Impacts’ regime (“PAI”) of the EU financial legislation.

Although most part of the legislation discussed is directed to financial firms, we emphasise that the rules will affect other companies in a substantial way. There are three main reasons for that:

  1. The holders of the company’s debt and equity (e.g. private equity funds) will mandate or require this;
  2. Compliance affects the cost of debt and equity;
  3. Larger companies are subject to more extensive disclosure requirements due to revised EU rules.

The PAI Regime has applied as of March 2021, but the new requirements will apply from 2022-23.

The obligations and content requirements are extensive and will require management time and procedural changes in firms as well as compliance resources and broad tracking of all investments and investee companies compliance with the indicators.

Principal Adverse Impacts and Financial Disclosure

We expect financial firms, and other firms through either ownership impact of markets, to face considerable amount of work and analysis in 2022 due to the PAI Regime. Although, the disclosure part of the more detailed new obligations will only commence as of 2023, the rules require in practice detailed research, analysis and supply-chain management and procedural and management work throughout 2022. We provide below a summary of the points that financial institutions should carry out in 2022 and what other corporations should understand of these obligations and changes.

What Does it Mean

The PAI in connected to Sustainable Finance Disclosure Regulation (SFDR), a regulation that was briefly introduced in our last post and that will be discussed extensively in our ESG posts throughout the Spring of 2022. 

The underlying point of the SFDR is that financial institutions and financial advisers are obligated to disclose on the entity and product level of extensive information about the firm and the underlying assets connected to sustainability factors. This obligation is connected to organise the firm’s decision-making in a specific manner and for that purpose the firm must be aware of e.g. all relevant adverse impacts its decisions, products and advice may have. It is also directly connected to firms’ compensation policy.

Importantly here, it means investigating, carrying out due diligence and setting up internal procedures to know all such matters and implement sustainability matters in the decision-making. Needless to say, this will be an extensive, on-going and demanding endeavour for all financial firms. The financial supervisory authorities have clearly expressed their view of regulatory emphasis of compliance with these obligations and ensuring no ’green-washing’ will occur.

The First Reference Period for the PAI

In November 2021, the application of the PAI regime was postponed to 1 January 2023. The first disclosure requirements of the PAI regime will have to be made the first time by 30 June 2023, for the reference period starting 1 January 2022. This means that the first reference period has already started. Despite, we are still waiting for the publication of the final delegated rules relating to the SFDR.

Overview of the PAI Regime

The PAI regime applies to certain financial market participants[1] and financial advisers[2]. Although, the main obligations in relation to the PAI regime can be found in the SFDR, it should be noted that the EU investment services legislation has been amended in 2021 to include PAI requirements applying to also to investment firms’ decision-making. E.g. EU Commission Delegated Regulation requires that the firms ask from their clients and comply with their clients’ sustainability preferences which refers to ‘financial instrument that considers principal adverse impacts on sustainability factors where qualitative or quantitative elements demonstrating that consideration are determined by the client or potential client’.[3] Similar new rules apply also to AIFMs (funds) and UCITS.

In effect, compliance with the above obligations means that investment firms must have identified beforehand throughout their supply chain, investment process and investee firms what these principal adverse impacts are. Deviating from the scope of the SFDR, these obligations apply to all MiFiD II products, which is likely to ‘push’ the initial scope from the SFDR covered firms to other companies as well. 

Scope of the Rules

Financial advisers are subject to a more lenient regime under the SFDR. They can comply with the PAI entity level requirements set out in the SFDR. However, they can, irrespective of their size, opt out from the regime.[4]

The regime applies more broadly to financial market participants. They are subject both to the entity level disclosure and product level disclosure obligations. Small companies[5] can opt of the regime, but the company must be able to explain the grounds of such a decision. Arguably, due to the structure and the objectives of the law, it is likely that market pressure will require compliance also in relation to small firms. However, if smaller firms opt out of the regime, they will have to give prominently in their web-pages clear reasons why this is the case and whether they will and when consider PAI in their operations.

Large financial market participants will have to comply with all of the PAI Regime obligations and also follow the detailed Annex 1 of the Regulatory Technical Standards.

The ‘Entity Level’ Requirements

The PAI Regime is most relevant under so-called entity level disclosure rules when making investment decisions on sustainability factors. Some aspects of the ‘product level’ rules and PAI are discussed in the following posts. The entity level disclosure focuses on a document called the PAI statement. In effect it is a detailed description on due diligence policies with respect to PAI noting the scale and size of their operations and the offered financial products.

The PAI statement must contain:

  1. policies on identification and prioritisations of the PAIs and their indicators;
  2. description of the PAIs and actions planned and taken in relation to them;
  3. summaries of engagement policies (for asset managers and institutional investors) set out in the EU shareholder rights directive;
  4. reference to adherence to responsible business conduct rules and international due diligence and reporting standards and the degree of their alignment with the Paris Agreement.

The above sections of the statement are specified in Final Report on draft Regulatory Technical Standards (RTS) by the European Supervisory Authorities through their Joint Committee. The current draft version was published 22 October 2022 and we have worked under the assumption this document represents a well advanced standard of what the final technical rules will be. The focus here is on the entity level requirements. 

Contents of the PAI Statement

The statement must follow Annex 1 of the RTS.

The final draft tables to be complied are ca 20 pages long; they include 32 mandatory extensive data items and 18 optional data items – both qualitative and quantitative and will require material resources to be prudently analysed and disclosed. These include e.g. calculations of relative valuations detailing each investee companies carbon emissions.

The titles and the sub-topics of the statement will have to be (in this order):

1. Summary (in Finland: in Finnish or Swedish and in English and the language where products are marketed)

  • Name and identification of the firm
  • Statement on consideration of PAIs
  • Reference period
  • Max 2 A4 page summary PAI Statement (see below)

2. Description of the principal adverse sustainability impacts

  • The PAI indicators (Table 1)
  • At least one climate or environment-related PAI (Table 2)
  • At least one social, employee, human rights, anti-corruption or anti-bribery-related PAI (Table 3)
  • Any other identified PAIs.
  • Actions taken in relation to (i-iv) for the reference period and the targets for the next one
  • The assessment of i-iv should be based on four quarterly calculations
  • Historical comparisons must range (after the respective periods to at least five previous reference periods

3. Description of the policies to identify and prioritise principal adverse sustainability impacts

  • Policy approval date (governing body)
  • Allocation of implementation responsibility withing strategies and procedures
  • Methodologies (also probabilities and severity of impacts and possible irremediable factors) for selecting the indicators mentioned above in point 2
  • Margins of error
  • Data sources
  • If the indicators data is not readily available, details of the best efforts to obtain data from investee companies or from third party data providers or making reasonable assumptions

4. Engagement Policies

  • Reference to the engagement policies set out in the Shareholder Rights Directive
  • Summaries of other engagement policies including description of the used indicators and how these policies are adapted if there is no reduction of PAIs over more than one reference period

5. References to international standards

  • Adverse impact indicators to measure alignment with standards (same as under point 2 above) Method and data used to measure alignment (as well as forecasting)
  • Identification of a possible forward-looking scenario and its details
  • An explanation if a forward-looking scenario is not used and why that is not deemed relevant


We encourage our Clients to review in detail the key indicators and the required PAI procedures in the first part of 2022. We are able to provide the more detailed rules and key indicator requirements as tables upon request and advice how a firm might want to implement these in their decision making and management decisions.

In practice, setting up the data sources, analysis and implementation these into the firm’s organisation will take extensive resources and at least months to implement. 

Prudent management of the ESG regime is also important from the Board’s liability perspective. Most importantly, high-class ESG compliance will promote common interest of us all to environmental and social protections, which is of the utmost importance for all stakeholders.

[1] (a) an insurance undertaking which makes available an insurance‐based investment product (IBIP); (b)  an investment firm which provides portfolio management; (c)  an institution for occupational retirement provision (IORP); (d) a manufacturer of a pension product; (e)  an alternative investment fund manager (AIFM); (f)  a pan‐European personal pension product (PEPP) provider; (g) a manager of a qualifying venture capital fund registered in accordance with Article 14 of Regulation (EU) No 345/2013; (h) a manager of a qualifying social entrepreneurship fund registered in accordance with Article 15 of Regulation (EU) No 346/2013; (i) a management company of an undertaking for collective investment in transferable securities (UCITS management company); or (j) a credit institution which provides portfolio management

[2] (a)  an insurance intermediary which provides insurance advice with regard to IBIPs; (b) an insurance undertaking which provides insurance advice with regard to IBIPs; (c)  a credit institution which provides investment advice; (d) an investment firm which provides investment advice; (e) an AIFM which provides investment advice in accordance with point (b)(i) of Article 6(4) of Directive 2011/61/EU; or (f) a UCITS management company which provides investment advice in accordance with point (b)(i) of Article 6(3) of Directive 2009/65/EC.

[3] Please see EU Commission Delegated Regulation 1253/2021:

[4] Also they do not have to comply with Annex 1 of the Regulatory Technical Standards concerning the contents and form of the PAI disclosure.

[5] Less than the average of 500 employees during the financial year. It should be noted calculation of the threshold is extended the group of the parent company of ’large groups’ as defined in MifiD II.