EU Sustainable Finance Disclosure Regulation (SFDR)
What does the EU Sustainable Finance Disclosure Regulation (SFRD) mean for investment professionals?
From March 2021 onwards, this new regulation requires all financial market participants to disclose Environmental, Social & Governance (ESG) issues. The aim of the regulation is to limit the risk of greenwashing by financial market participants while increasing transparency, making it easier for investors to understand how ESG and sustainability factor into their investments. This new regulation applies to banks, insurance companies, investment firms, and Alternative Investment Funds marketing their funds in the European Union.
I am a fund manager, what exactly am I required to do?
The regulation outlines two different types of disclosures that finance professionals must offer:
Firstly, there are disclosure requirements at the entity-level which must be published on your website: by March 2021, you must:
- publish a general policy on the integration of sustainability risks in investment decisions/advice,
- clarify the alignment of your remuneration policy with identified sustainability risks, and
- explain the due diligence policies regarding Principal Adverse Impacts on Sustainability (PAIS) in terms of investment decisions.
The second type of disclosure concerns the financial products themselves. This disclosure should be performed on your website and in pre-contractual communication such as product brochures, prospectus, etc. Initially, by March 2021, you are required to outline the characteristics, objectives, and methodologies adopted for the monitoring and assessment of sustainability risks. You must explain how these sustainability risks are integrated into your investment strategy, and how they may affect the returns of your investment products. Following the “comply or explain” approach, in case you do not integrate sustainability risks in your investment strategy, you are required to explain why this is the case. At the product level, you will also need to publish whether the product considers principal adverse impacts on sustainability, and if this is not the case, you will need to explain why.
For products that are explicitly marketed as ‘ESG’, ‘SRI’, or ‘sustainable’, there are additional requirements:
- Explain how your strategy is ‘sustainable’, and compare it to similarly ‘non-sustainable’ investment products.
- Outline which environmental characteristics the financial product promotes, or which environmental objectives it aims to achieve. This also includes an analysis of the sustainability alignment of this financial product with the EU Taxonomy Regulation.
The complexity and depth of your disclosure depend on the characteristics of the ‘sustainable’ financial products. Depending on whether the financial product considered is a ‘sustainability-themed investment’, a ‘Best-in-Class Investment Selection’, uses ‘Norms-Based Screening’, adopts ‘Exclusionary Screening’, performs ‘ESG Integration’, or is an ‘Impact Investment’, the requirements vary. In broad terms, mainstream investment products (sustainable or not) must follow Article 6 of the SFRD, products promoting Environmental or Social characteristics must comply with Article 8, and finally, products with sustainable investment objectives must follow Article 9.
Some key definitions which can help you understand the requirements:
- Sustainability Risks [art. 2(2)] → ESG events that could have a negative impact on the value of the investment.
- Sustainability Factors [art. 2(24)] → impact of the investments on the real world: E, S & employee matters, respect of HR, anti-corruption/bribery matters. This thus refers to the Principal Adverse Impact Indicators.
- Sustainable Investment [art. 2(17)] → investment in an economic activity that contributes to an E or S objective provided that it does not significantly harm any of those objectives and that the investee companies follow good G practices.
- Double materiality: sustainability risks impacting the portfolio + impact of the portfolio on sustainability indicators.
Above we provided you the legal obligations with which financial market participants will have to comply. Wequity can support you in compliance with these regulations, and go further depending on your ambitions with regards to ESG Strategy.