As part of the European Commission’s Action Plan on financing sustainable growth of March 2018, Regulation (EU) 2019/2088 on Sustainable Finance Disclosure Regulation (SFDR) aims to provide greater transparency on the degree of sustainability of financial products to channel private investment towards sustainable investments. Some of the EU taxonomy requirements will also help to achieve this purpose by requiring those financial products to disclose to what extent they invest in environmentally sustainable economic activities. The phase-in implementation of SFDR started from 10 March 2021.
About SFDR – Sustainable Finance Disclosure Regulation
The Sustainable Finance Disclosure Regulation (SFDR) defines and introduces transparency requirements on financial products’ characteristics that can be used and compared to assess their degree of sustainability.
Regulatory requirements of SFDR
The regulatory requirements of SFDR focus on the transparency of:
- Consideration of sustainability risks that are risks of loss of value of underlying assets due to environmental or social events;
- Sustainable investments in economic activities that contribute to environmental or social objectives. They include investments in EU-taxonomy eligible economic activities;
- Consideration of Principal Adverse Impacts (PAI) on sustainability factors, which are the negative effects on environmental, social and employee matters as well as respect for human rights, anti-corruption and anti-bribery resulting from an investment decision.
Sustainable finance: our regulatory intelligence
Scope of SFDR – Sustainable Finance Disclosure Regulation
Financial products and product manufacturers in scope of SFDR
As of 10 March 2021, SFDR applies to the financial products listed below and extends to their product manufacturers and their financial advisers who are located in the EU:
- Portfolios managed by credit institutions or investment firms
- Alternative investment funds (AIFs) and UCITS
- Insurance-based investment products (IBIPs)
- Pension products, workplace pension products regulated under the IORP directive and PEPP
Disclosure obligations of SFDR
As of 10 March 2021, all in-scope financial products have to disclose in pre-contractual documents how they consider sustainability risks and the expected impact on the return of the product. Their product manufacturers and advisers have to disclose information on the integration of sustainability risks in the investment decision-making process or the investment advice process as well as information on how remuneration policies are consistent with the integration of sustainability risks.
Financial products “promoting ESG characteristics” or “investing in sustainable investments” must disclose in pre-contractual documents detailed information on those characteristics or investment objectives and associated sustainability indicators and, in periodic reports, information on how they have been attained.
Consideration of Principal Adverse Impacts under SFDR
The ways in which Principal Adverse Impacts (PAI) on environmental and social matters resulting from an investment decision are considered must be disclosed as follows:
- By financial market participants, on a “comply or explain” basis from 10 March 2021
- By entities subject to the Non-Financial information Reporting Directive(1) (NFRD), on a mandatory basis at entity level from 30 June 2021
Disclosure including PAI indicators will be done in compliance with the RTS from 30 June 2023 for financial market participants and in the periodic reports of financial products from 30 December 2022.
Industry implications of SFDR – Sustainable Finance Disclosure Regulation
Financial products that do not claim to achieve any degree of sustainability may face marketing difficulties as they will have to clearly disclose in their pre-contractual documents that they do not consider sustainability risks, PAI on sustainability factors or EU taxonomy criteria that define environmentally sustainable economic activities. Moreover, under MIFID II amendments that will be apply from 2 August 2022, products that do not consider PAI on sustainability factors or that do not invest in sustainable investments will no longer be advised to clients that have expressed ESG preferences.
RTS under SFDR
On 6 April 2022, the European Commission adopted the final Regulatory Technical Standards (RTS) under the Sustainable Finance Disclosure Regulation and its Annexes, including the entity-level Principal Adverse Impact (PAI) reporting template and indicators (Annex 1) and the mandatory pre-contractual / periodic templates for Article 8 and 9 products (Annex 2, Annex 3, Annex 4 and Annex 5).
Those implementing texts further specify the ESG data required to meet the transparency requirements.
The content of the statement on PAI to be produced at entity level and the mandatory PAI indicators will only have to be published for the first time from 30 June 2023 for the reference period of the calendar year 2022.
Securities Services’ view
Room for interpretation remains regarding the definitions introduced by SFDR.
- In April 2022, the European Supervisory Authorities (ESAs) published Q&As to clarify that all underlying assets of Article 9 products must qualify as sustainable investments. Subsequently, some asset managers have reclassified funds from Art. 9 to Art. 8 products that only promote ESG characteristics.
- The European Commission intends to publish in 2023 a consultation on SFDR with a particular focus on how the regulation can ensure legal certainty, usability and prevent greenwashing.
ESAs have also required clarification from the European Commission in April 2022. One of the questions asked by the ESAs is whether a fund’s holding in a company can be considered as a 100% sustainable investment if that company only receives a portion of its revenue from sustainable activities. The responses from the Commission are not expected before April 2023.
- ESMA has written to the European Commission to delay the publication of its review of PAIs in the RTS and its advice to the Commission on minimum sustainability criteria for Article 8 products until October 2023.
Another main issue raised by product manufacturers is that they are required to access ESG data that are not made publicly available by investee companies and are therefore costly.
From 2025 this issue will be partially resolved with a proposal by the European Commission for the review of the NFRD published in 2021, the Corporate Sustainability Reporting Directive (CSRD), and by the adoption of a legislative proposal in Q3 2021 to create a European Single Access Point that provides EU-wide access to all relevant information (including on sustainability) disclosed to the public by companies, as put forward by the European Commission in its new Capital Markets Union (CMU) action plan. It is important to note that all information will be provided in comparable digital formats.
Key dates of SFDR – Sustainable Finance Disclosure Regulation
29 December 2019 – Entry into force of SFDR
10 March 2021 – First application date for the disclosure requirements at entity level and in pre-contractual documents at product level in accordance with the principle-based requirements of the regulation
30 June 2021 – Disclosure by product manufacturers (500+ employees) of their policies in consideration of PAI on sustainability factors
1 January 2022 – For financial products with ESG characteristics or objectives in sustainable investment, first application date for the disclosure requirements in periodic reports at least in accordance with the principle-based requirements of the Regulation and for requirements specified in RTS
6 April 2022 – Adoption by the European Commission of the final Regulatory Technical Standards (RTS) under the Sustainable Finance Disclosure Regulation (SFDR).
1 January 2023 – Entry into application of the RTS and disclosure in consideration of adverse sustainability impacts for financial products of large product manufacturers
30 June 2023 – Disclosure of PAI indicators by large product manufacturers
With SFDR phase 2, are your investment compliance capabilities ready?
 In 2014 the EU agreed Directive 2014/95/EU (the Non-Financial Reporting Directive or NFRD), an amendment to Directive 2013/34/EU (the Accounting Directive). The NFRD requires certain companies to report information regarding environmental, social and employee issues, human rights, and bribery and corruption, on an annual basis. The NFRD applies to large listed companies, banks and insurance companies with more than 500 employees. Companies under the scope of the NFRD had to meet these reporting requirements for the first time in 2018, for information covering financial year 2017.