The Sustainable Finance Disclosure Regulation (SFDR) is a new European Union regulation aimed 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 standardized format so that they can make informed decisions about their investments.
Non-compliance with SFDR can have several adverse consequences as reputational penalty (“name & shame”), disciplinary penalty (being on the radar of local financial authorities, AMF’s notice in France for instance) and market penalty (bad signal sent to current and prospective investors and clients).
This article will walk you through the SFDR's latest requirements and how to meet them for optimal compliance.
SFDR stands for Sustainable Finance Disclosure Regulation and is part of a raft of EU legislation (alongside the EU Taxonomy and CSRD). It came into effect in March 10, 2021.
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 compels 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.
The SFDR takes the form of extra disclosures to financial market participants through websites, prospectuses, and quarterly reports.
In essence, the SFDR is intended to remove barriers that hinder investors from getting the sustainability data they need to make sound investment choices. The SFDR's three primary objectives are as follows:
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.
To begin, it makes it more difficult for asset managers to "greenwash" their goods; in other words, they cannot just 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.
Larger organisations (defined as those with an average of 500 workers or those that are parent companies of a large group with an average of 500 employees) are subject to all SFDR’s disclosure requirements.
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.
The EU SFDR defines three separate kinds of investment products in terms of sustainable investing and environmental, social, and governance (ESG) considerations:
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.
Article 8 financial products promote environmental and/or social qualities and may invest in sustainable initiatives, but 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".
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 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 anything from greenhouse gas emissions to waste management, biodiversity, and human rights. This is rapidly becoming the minimal requirement, and businesses that fail to meet it will face severe consequences.
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 have until the end of June 2023 to disclose mandatory and additional PAI indicators in their PAI Statement (covering the calendar year 2022).
Since March 2021, the following disclosure are required at financial product level:
The Sustainable Finance Disclosure Regulation deadline is approaching and it's important to meet its requirements to not risk any non-compliance penalties.
At Apiday, we built a tool to help you understand and comply with the Sustainable Finance Disclosure Regulation by generating all disclosures required.
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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 business. Let us help you take the hassle out of SFDR compliance, try our tool today!