European Union’s Sustainable Finance Disclosures Regulation (SFDR)
Given the growing importance of sustainability and the increased commitments to achieving the objectives set under the Paris Climate Agreement and the UN Sustainable Developments Goals (SDGs), countries worldwide are enacting policies and regulations to facilitate private capital through the financial markets into firms that promote sustainability.
Timely and Material Information is essential for the effective functioning of the financial markets and efficient allocation of capital. The European Union has created a framework for accomplishing this through 3 regulations – EU Taxonomy, CSRD and SFDR.
- The EU Taxonomy, currently only focusing on environmentally sustainable activities, guides what economic activities can be classified as sustainable (more information)
- The Corporate Sustainability Reporting Directive (CSRD) mandates non-financial firms to disclose their sustainability performance and investments in and outcomes of EU taxonomy classified economic activities. (more information)
- The Sustainable Finance Disclosures Regulation(SFDR) mandates financial firms to undertake sustainability disclosures.
Together, these regulations help minimize misallocation of capital that may happen due to lack of material information or through the promotion of products using misleading information (or “greenwashing”). In addition, these regulations reduce information asymmetry between the different market participants by increasing transparency. In this article, some of the key highlights of the EU SFDR will be explored.
SFDR is applicable for “financial market participants and financial advisers”. Financial market participants include, among others, investment firms and pension product providers. The range of financial products includes, but is not limited to, financial investment portfolios, alternative investment funds and pension products.
Key disclosure requirements
The key disclosure requirements are described in various “Articles” within the SFDR. The Articles describe requirements at the company level and product level.
- Company or firm-level disclosures
- These disclosures provide details about the “Sustainability Risks” and “ Principal Adverse Impacts(PIA)”. They also cover remuneration policies and pre-contractual disclosures on sustainability risk integration. Just like the Corporate Sustainability Reporting Directive (CSRD), the SFDR also mandates disclosures by Financial Market Participants (FMP) and Financial Adviser (FAs) based on “Double Materiality” principles(more on double materiality here). Financial Materiality is captured in the “Sustainability risks” disclosures and the Impact Materiality is captured in the “Principal Adverse Impacts (PAI) on sustainability factors”. Read our detailed article on the Principal Adverse Impacts here.
- These requirements are covered under Articles 3,4, and 5 of the SFDR.
- Product level disclosures
- These disclosures are meant to help investors choose between different financial products based on their level of sustainability.
- These funds are classified into three categories which are described in Articles 6, 8 and 9 of the SFDR. These funds respectively integrate, promote or target sustainable investments.
- Article 6 describes strategies that either integrate ESG considerations into their decision-making process or explain why these considerations are not relevant for the funds.
- Article 8 describes strategies that promote ESG factors in investments.
- Article 9 describes strategies that have sustainable investments as the primary objective.
- The SFDR becomes effective in a phased manner, with the “Level 1” disclosure going into effect in March 2021 and the “Level 2” disclosure scheduled to become effective in January 2023.
Update 1: On May 25, 2022, the US SEC proposed the “Names rules” to ESG funds to prevent misleading claims or greenwashing. The proposed rule is that “ funds with “ESG” in their name would have to clearly define the term and then ensure that 80% of the assets in the fund adhered to that definition.” Read our analysis on the “Names rule” here and the classification of funds here. More here.
NordESG is an independent consulting firm that advises on sustainability and ESG. We support companies in navigating their sustainability landscape and develop strategies and concepts individually tailored to their requirements. This also includes managing the transition to CSRD. We look forward to hearing from you via email. You can also make an appointment with us directly for a free introductory meeting.
Sources and more information
EUR LEX on the SFDR https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=celex%3A32019R2088