The Sustainable Finance Disclosure Regulation (SFDR): What You Need to Know
What is the SFDR?
The SFDR, effective since 10 March 2021, imposes mandatory Environmental, Social and Governance (ESG) disclosure obligations for financial market participants (FMPs) and financial advisers. It was introduced by the European Commission alongside the Taxonomy Regulation and the Low Carbon Benchmarks Regulation as part of the EU’s Action Plan on Sustainable Finance. The plan is a major step towards redirecting capital to the sustainable economy.
Why was it created?
The SFDR has two main goals: to increase transparency on sustainability within financial markets and to create reporting standards for sustainable investing. As such, it renders greenwashing by asset managers more difficult by demanding information on the process and portfolio behind a product with an ESG or sustainable label. It will also facilitate comparisons between investment options in terms of sustainability and ESG factors, thus helping investors make informed decisions that align with their investment goals.
Who is in scope for it?
The SFDR applies to all FMPs, which are all entities offering financial products where they manage clients, and financial advisors in all investment processes and for financial products that pursue the objective of sustainable investment. Investment managers or advisers based outside the EU but wishing to market their products to clients in the EU will also need to comply. In-scope financial products include investment and mutual funds, insurance-based investment products, private and occupational pensions, and insurance and investment advice.
How to comply
Asset managers and advisers will need to disclose how they consider two factors: sustainability risks and Principal Adverse Impacts (PAI). Sustainability risks are defined as ESG events or conditions which could cause a material negative impact on the value of an investment. PAIs are negative effects that investment decisions or advice could have on sustainability factors. Asset managers will have to disclose their policies at both the firm and product level, while advisers will have to explain how they consider these factors in their advice.
The main provisions (Level 1) of the SFDR have applied since 10th March 2021. FMPs need to provide a description of relevant PAIs, any actions taken or planned with relation to them, and engagement policies. These disclosures currently apply on a ‘comply or explain’ basis, except for large financial market participants (those with more than 500 employees), which are ‘comply’ only. In the second stage of SFDR (level 2), FMPs will be required to detail how they consider PAI into more quantifiable detail, in line with specific environmental, social, and governance indicators.
The SFDR also requires firms that claim their products have sustainable characteristics or objectives to make a product level disclosure. As such, investment products are classified into three distinct categories: those that have sustainable investment as their core objective (Article 9), those that promote environmental and/or social characteristics but do not have sustainable investing as a core objective (Article 8), and other investment products (Article 6).
Looking ahead
More detailed disclosure requirements relating to disclosures in the periodic reports of ESG-focused products were planned to apply from 1 January 2022 (Level 2). However, the draft regulatory technical standards (RTS) could not be adopted by the commission within the time period due to its complexity, and so the application of the delegated act was postponed to January 2023. The RTS includes guidelines that FMPs must follow to align their products with their desired label and requirements for disclosure regarding PAIs.
The new application date means that entities will now have to comply with the publication of PAI at entity level by 30 June 2023, to cover the year 2022. The following year, in 2024, disclosure will be complemented by a historical (year on year) comparison between the first and reference periods where PAI data was applied.
The postponed date will give FMP’s time to prepare for the new reporting requirements and allow for national competent authorities to prepare for the effective supervision of compliance. In the interim period, it is recommended that FMPs and advisors that wish to apply the provisions of the SFDR without the RTS refer to the requirements set out in the draft RTS of the final reports, which were submitted to the European Commission on the 4th of February and the 22nd of October 2021.
How we can help
Orbis Advisory work across a broad range of sectors to develop and support ESG strategies to meet investor demands, prepare for upcoming legislative changes, and create tangible benefits both now and in the future. Please see our website to explore our full range of services. For any inquiries, send an email to info@orbisadvisory.com, or fill out an online enquiry form.
Sources:
https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32019R2088&from=EN
Sustainability-related disclosure in the financial services sector | European Commission (europa.eu)
