Optional PAI Indicators and Due Diligence

Beyond the 14 mandatory PAI indicators in Table 1 and the mandatory sovereign and real estate indicators in Tables 4 and 5, the RTS provides an extensive set of optional additional PAI indicators in Tables 2 and 3. Firms can select any number of these indicators to supplement their mandatory reporting.

In plain English: the mandatory indicators are the baseline that every firm must report. The optional indicators let firms go further, and in some cases, they should, particularly if their funds have specific environmental or social themes that the mandatory indicators don't fully capture.

This lesson explains the optional indicator framework, discusses criteria for selecting indicators, and examines the due diligence obligations that underpin the PAI consideration requirement.

The Structure of Optional Indicators

Table 2 contains additional environmental indicators for investments in investee companies. These cover:

• Emissions to water (waste water generation, water pollutant intensity)
• Hazardous waste (total and ratio per revenue)
• Natural species and protected area impacts
• Deforestation (land use change, deforestation metrics)
• Carbon intensity of real estate investments

Table 3 contains additional social indicators for investments in investee companies. These cover:

• Exposure to companies with discriminatory practices
• Child labour in investee companies' value chains
• Forced labour exposure
• Excessive CEO-to-worker pay ratio
• Human rights policy gaps
• Supply chain due diligence gaps
• Anti-corruption policy gaps
• Whistleblower mechanism gaps
• Countries with significant corruption perception concerns

Selecting Optional Indicators, Criteria

The RTS does not prescribe which optional indicators firms must select if they choose to report beyond the mandatory set. Guidance from supervisors and industry practice suggests selecting optional indicators based on:

1. Materiality to investment universe

If the portfolio has significant exposure to sectors with high water use (e.g., beverages, semiconductors, agriculture), optional water-related indicators from Table 2 are more relevant than for a technology-focused portfolio. Materiality should drive selection.

2. Alignment with promoted characteristics

An Article 8 fund promoting social characteristics should consider Table 3 social indicators that go beyond the mandatory indicators. A fund specifically promoting human rights should consider all available human rights indicators.

3. Alignment with sustainable investment methodology

For Article 9 funds, optional indicators may serve as DNSH measurement tools for environmental and social objectives that are not captured by the mandatory indicators. A fund with an ocean sustainability objective might use emissions-to-water indicators.

4. Data availability

There is limited value in reporting an optional indicator if the data coverage is so poor that the result is based almost entirely on estimation. FMPs should assess data availability before committing to report an optional indicator consistently.

The "At Least One" Rule for Additional Indicators

The RTS requires that every FMP publishing a PAI statement must report at least one additional indicator from Table 2 (environmental) and at least one additional indicator from Table 3 (social), in addition to all 14 mandatory Table 1 indicators and the applicable Table 4/5 indicators. This is not optional, it is a mandatory minimum for the PAI statement. The FMP may choose which additional indicators to report, but must include at least one from each optional table. An FMP cannot choose to report only additional environmental indicators and ignore the social dimension, or vice versa.

Due Diligence Obligations

PAI consideration is not merely a reporting exercise, it is grounded in a due diligence obligation. Article 4 of SFDR requires FMPs that consider PAI to maintain due diligence policies regarding PAI. These policies must describe:

1. How PAI are identified and prioritised

The FMP must have a documented process for determining which PAI are most material for its investment universe and strategy. This may involve a double materiality assessment, identifying which environmental and social topics are most relevant given the sectors, geographies, and asset classes invested in.

2. How PAI information is collected and used

The policy must describe data sources, data collection processes, and how PAI data feeds into investment decisions. Is high PAI score a basis for exclusion? For engagement? For reduced portfolio weight? The policy should be specific about the decision-making linkage.

3. Engagement policies related to PAI

Where FMPs use engagement with investee companies as a tool for reducing PAI, the due diligence policy should describe the engagement framework. How are companies with high PAI scores engaged? What timelines and escalation processes apply? Under what circumstances does the FMP disinvest after unsuccessful engagement?

4. Actions and targets

The due diligence policy should include actions the FMP plans to take or targets it has set to reduce identified PAI over time. The RTS requires PAI statements to include information on actions taken and targets set for the following reference period.

PAI and Investment Stewardship

For many FMPs, PAI consideration is most effective when integrated with their shareholder engagement and stewardship programmes. Rather than using high PAI scores as a blunt exclusion trigger (which may be appropriate for some indicators like controversial weapons), firms can use PAI data to identify companies for engagement and set measurable improvement targets.

For example, an FMP with a high portfolio-level carbon footprint PAI might:

1. Identify the top ten contributors to that indicator in the portfolio
2. Engage with those companies' boards and management teams on emissions reduction targets and science-based targets (SBTs)
3. Set a portfolio-level carbon footprint reduction target (e.g., 10% reduction year-on-year)
4. Report in the following year's PAI statement on progress against that target and the results of engagement activities

This integration of PAI measurement, engagement, and target-setting creates a meaningful feedback loop that is more valuable, for both investors and society, than pure disclosure.

Historical Comparison Requirement

From the second year of PAI reporting, firms must include a historical year-by-year comparison for at least the five most recent reference periods, where available. This comparative data requirement serves two purposes:

• It enables investors to track trends in the firm's portfolio-level sustainability impact over time
• It creates accountability, firms that claim to be improving their PAI performance can be held to that by reference to the historical data

Where a firm first considers PAI (either voluntarily or because it has grown above the 500-employee threshold), the first-year statement need only cover the current reference period. The historical comparison requirement builds over subsequent years.