The Sustainable Finance Disclosure Regulation (SFDR) is European Union regulation mandating ESG disclosure obligations for asset managers and other financial markets participants with substantive provisions of the regulation effective from 10 March 2021. The Regulation aims at increasing transparency and boosting environmental and social responsibility in the finance industry.
The SFDR requires banks, insurers, investment firms, and other financial institutions to report their sustainable investment practices to investors in a standardised format so that they can make informed decisions about their investments.
Non-compliance with SFDR can have adverse consequences, including negative impact on the reputation of company or firm, disciplinary action from local financial authorities, negative signaling to current and prospective clients and investors.
This article will walk you through the SFDR's latest requirements and how to meet them for optimal compliance.
The SFDR strives to create a level playing field for financial market participants ("FMPs") and financial advisers in terms of transparency regarding sustainability risks, consideration of adverse sustainability impacts in investment decisions, and the provision of sustainability-related information about financial products.
The SFDR urges financial market participants and financial advisers, such as AIFMs and UCITS managers, to provide mandatory and standardised disclosures on how ESG elements are incorporated at both the entity and product level.
Disclosures indicated in the SFDR can be shared with financial market participants in the form of a website, prospectus, or quarterly report.
Envisioning removal of barriers that inhibit access to requisite sustainability data for informed investment decisions by asset managers and investors, the SFDR seeks to achieve three key objectives:
As discussed beforehand, the fundamental objectives of the EU SFDR are to increase openness about environmental and social aspects, as well as sustainability, in financial markets, and to establish consistent criteria for reporting and disclosing information pertaining to these issues.
Increasing openness and establishing standards contribute to two other critical factors.
One, it will make "greenwashing" tougher for firms and asset managers. In other words, It will make it tougher for companies to brand a product with an ESG or sustainable label without disclosing how this was accomplished.
Second, it considerably improves investors' capacity to evaluate investment choices in terms of the ESG aspects considered throughout the investment decision-making process, enabling them to make educated investment selections that match their investment objectives.
Overall, the SFDR is applicable to two types of financial institutions:
Among the companies that fit within these two groups are the following:
The SFDR primarily applies to financial institutions operating in the EU (banks, insurers, asset managers, and investment businesses). Non-EU firms will be impacted indirectly due to EU subsidiaries, services offered in the EU, and market pressure.
Investment managers or advisors operating outside the EU who advertise (or seek to market) their products to EU customers will also be required to comply with the SFDR disclosures.
Regarding the SFDR’s specific requirements on the consideration of principal adverse impacts (PAIs), organisations with fewer than 500 workers can comply with this entity-level disclosure requirement or explain why they do not examine the unfavourable effects of investment choices on sustainability criteria.
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The EU SFDR defines three separate kinds of investment products in terms of sustainable investing and environmental, social, and governance (ESG) considerations:
Article 6 applies to funds that do not incorporate sustainability into their investing strategy and may contain stocks that are presently excluded from ESG funds, such as tobacco businesses or thermal coal producers.
While they will be permitted to be offered in the EU as long as they are explicitly labeled as non-sustainable, they may have significant marketing difficulties when compared to more sustainable funds.
Article 6 items either include ESG factors into the investing process or explain why sustainability risk is irrelevant, but do not fulfill the extra standards of Article 8 or Article 9 strategies.
Also referred to as 'environmental and socially promoting", Article 8 applies where a financial product promotes, among other features, environmental or social attributes, or a mixture of those attributes, given that the enterprises in which the investments are made adhere to sound governance practices (light green).
While Article 8 financial products promote environmental and/or social qualities and may invest in sustainable initiatives, it's not as a primary purpose. Firms must examine if a fund supports "environmental or social qualities, or a combination of such characteristics, and, if so, whether the fund's investee firms adhere to good governance procedures".
Also dubbed 'products targeting sustainable investments', Article 9 refers to financial products that aim tailored sustainable investments and is applicable "... where a financial product has sustainable investment goals and an index has been established as a reference benchmark” (dark green).
The basic objective of Article 9 financial products is to encourage sustainable investment.
The SFDR defines sustainable investment as an investment in an economic activity that supports an environmental or social goal, given that the investment does not significantly undermine any environmental or social goal and that investee firms adhere to solid corporate governance norms.
The SFDR and the CSRD are closely linked in the European Union's framework for sustainable finance and corporate transparency. The CSRD mandates a broader range of companies to disclose detailed sustainability information, which directly supports the data needs of SFDR. By ensuring companies provide standardised, comparable, and reliable sustainability information, the CSRD effectively feeds into the SFDR's objectives, enabling investors and stakeholders to make more informed decisions. This synergy enhances overall transparency and drives the EU's agenda for a sustainable economy.
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The following information has been simplified for the purpose of this article. To know precisely what your company needs to do to comply with SFDR, reach out to our experts and test our SFDR feature.
Under the SFDR, financial entities have to disclose how they integrate sustainability factors into their decision-making process and what adverse impacts their financial products have on society and the environment.
Disclosure requirements cover 3 different scopes:
In addition to these levels of disclosure, a few concepts need to be understood:
This information is mainly to be disclosed on the website of the financial market participant or financial adviser.
For article 8 and 9 funds:
Fund-level requirements are to be disclosed in pre-contractual disclosures and updated on the website and in the fund’s periodic reports.
To comply with the SFDR requirement, businesses must declare their PAI, which includes greenhouse gas emissions, waste management, biodiversity, and human rights. Disclosures on PAIs is increasingly becoming important; businesses that fail to report and meet the basic requirements are facing multidimensional consequences in the short and long term.
The higher the quality of information available to fund managers, the more confidently they may include firms in their Article 8 or 9 funds.
According to the most recent data from Morningstar for Q3 2022, the market share of Article 8 and Article 9 fund assets continued to increase and reached 53.5% at the end of September 2022.
Nevertheless, a trend can be observed in recent weeks (after clarifications given by the regulator this summer): a growing number of Article 9 funds are being downgraded to Article 8.
In light of all these recent developments and in expectation of further downgrades, it can be expected that the number of Article 9 products will decline in the next six months from its current level of 1,080 funds (representing 4.3% of funds distributed in the EU).
Financial market participants may explore the following first efforts to comply with the SFDR and anticipate their capital providers' sustainability disclosure requirements:
The SFDR came into effect in March 2021. Since then, financial market participants and financial advisors have been expected to disclose the following:
Financial market participants and financial advisors had until the end of June 2023 to disclose mandatory and additional PAI indicators in their PAI Statement (covering the calendar year 2022).
The following disclosure are required at financial product level:
June 30, 2024 is the final deadline for financial market participants to submit the second report. Starting from this point, they are also required to compare data from the first and second reference periods.
The Sustainable Finance Disclosure Regulation is enforced and it's important to meet its requirements to not risk any non-compliance penalties.
At Apiday, our tool is designed to simplify your compliance with the Sustainable Finance Disclosure Regulation (SFDR) by generating all the required disclosures.
But that's not all – we also extend our support to the Corporate Sustainability Reporting Directive (CSRD).
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It's important to meet SFDR requirements to not risk any non-compliance penalties!
Our SFDR Compliance feature streamlines the data collection and analysis process to help you comply with the regulation. You can reduce the time and effort required to comply with SFDR, minimise regulatory risks, and enhance your reputation as a sustainable firm. Let us help you take the hassle out of SFDR compliance, try our tool today!
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