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Nick Inge 22 June 2023

The Sustainable Finance Disclosure Regulation (SFDR) explained

The Sustainable Finance Disclosure Regulation (SFDR) is designed to increase sustainability transparency within the European finance system. Here's how it works.

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What is the SFDR and does it apply to you?

Are you a financial institution based in the European Union? Read on, as the Sustainable Finance Disclosure Regulation (SFDR) will impact you. The SFDR regulations have scope to apply to all financial market actors in the EU, regardless of whether you claim to have sustainable financial products or not!

The SFDR is a critical European Union regulation designed to increase sustainability transparency within the finance industry.

Simply, it requires banks, asset managers, investment firms, and other financial institutions to offer to their investors standardised ESG disclosures in order to make informed decisions about their investments. By removing barriers to accessing crucial sustainability data, the SFDR seeks to reduce greenwashing and encourage flow of capital to more sustainable assets.

Who does the SFDR affect?

Broadly, there are two types of financial actors who the SFDR applies to;

  • Those selling portfolio services or financial products
  • Those providing advice on investments and insurance-based investment products (IBIPs).

These financial actors will typically be;

  • Portfolio Managers (Venture Capital, Fund Managers, Private Equity, Pension Funds)
  • Lenders - Banks & Private Creditors
  • Consultants providing financial advice
  • Insurers

Although the SFDR focuses on the EU, non-EU firms offering services or marketing their products within the region, will be compelled to align with the SFDR.

What are articles 6, 8 and 9 under the SFDR?

Articles under the SFDR help us classify the sustainability ethos of a certain fund and draw boundaries around the language funds can use to market their products. Funds claiming article 8 and 9 must be able to justify so through aligned SFDR performance.

Article 6: Funds without a sustainability scope or mandate

Article 8: Funds supporting ESG initiatives (such as screening)

Article 9: Funds with explicit sustainability objectives (higher impact focused)

Whether a fund is promoted as ESG or not, the baseline (article 6) requires asset managers to disclose the integration of sustainability risks in their funds. Any investment promoting ESG integration however, are required to classify as being either an article 8 or 9 fund.

What are the specifics of the SFDR?

There are two main disclosure levels when implementing the SFDR.

  1. The Entity level (Information to be disclosed on the website of financial actors)
    • Explanation of how sustainability risks are considered in investment decision making
    • Remuneration alignment with sustainability risks
    • Principle Adverse Impacts (PAI’s): Considerations of adverse impacts that are caused by the investment decision on sustainability metrics.
  2. Financial Product Level (Information to be disclosed in pre-contractual disclosures and published on website with reporting)
    • The SFDR article which the product aligns with (6,8 or 9). If 8 or 9, the below also apply;
    • Sustainability risk management (ensuring decision making considers sustainability risks.
    • Principle Adverse Impacts (PAI’s): Considerations of adverse impacts that are caused by the investment decision on sustainability metrics.
    • Do no significant harm (ensuring that neither the environmental nor the social objectives are significantly harm)
    • Governance and minimum safeguard considerations

When does it apply?

The Sustainable Finance Disclosure Regulation (SFDR) took effect in March 2021, ushering in new obligations for financial market participants and advisors.

Financial market participants and advisors have been granted until the end of June 2023 to disclose mandatory PAI indicators in their PAI Statement for the calendar year 2022. At the product level, the following disclosures are required:

  1. Integration of sustainability risks into investment decisions and advice.
  2. Consideration or non-consideration of PAI.
  3. Pre-contractual disclosures for products promoting environmental or social characteristics and those with sustainable investment objectives.
  4. Inclusion of taxonomy-related disclosures for climate change objectives starting from January 1st, 2022.
  5. Inclusion of taxonomy-related disclosures for all environmental objectives starting from January 1st, 2023.
  6. Website disclosures specifically for Article 8 and 9 SFDR products.
  7. Periodic disclosures.
  8. Marketing communications that align with the SFDR disclosures.

Does everyone need to comply?

As outlined, there are a number of tiers to the SFDR disclosure requirements.

Organisations with over 500 employees are subject to each requirement under the SFDR and the entity level and product level. This is also applicable if that company is a subsidiary of a large company with over 500 employees.

i.e A small VC fund which is owned by a large bank.

Financial actors with less than 500 staff still need to either comply with entity level disclosure of PAIs or, explicitly explain why they are not considering sustainability criteria when making their investment decisions.

As time goes on and regulations tighten, more financial actors are opting to adopt SFDR practices as a matter of best practice, regardless of their specific regulatory thresholds at a moment in time.

So, if you’re a financial firm operating within the EU, it’s important to stay on top of your SFDR requirements so you remain ahead of the fast moving curve. Understanding the SFDR is one thing, but implementing it is a whole other conversation! We’re here to have that conversation with you and digitise the implementation of your SFDR solution. Let’s chat!