Introduction
The EU has introduced the Sustainable Finance Disclosure Regulation (SFDR) in 2019,appliying to financial market participants (FMP), such as asset managers, banks, financial advisors. The first level has come into effect on 10 March 2021 and will continue rolling out deadlines for disclosures that are required by FMPs. This regulation is focused within Europe but is being adopted by other countries around the globe. Its aim is to assist European commitments on climate control and Sustainability objectives, encouraging investors to chase greener opportunities which do no harm to the ESG (Environmental, Social and Governance).
SFDR Purpose
The purpose of the SFDR is to reorientate FMPs capital towards more sustainable investments. It’s also designed to ensure that all disclosures are transparent, easy to understand and clearly show the sustainability characteristics of their products, by doing this they can also counter greenwashing.
Greenwashing is the process of providing misleading information on how sustainably friendly a company’s products are. Often rebranding or repackaging, saying recycled materials are used, exaggerating this fact when only 5% of their material may be recycled would be some examples of green washing. With the SFDR requiring a paper trail of sources and evidence, they hope to eliminate this misleading information.
SFDR Scope Impacted Funds / Companies
The SFDR applies to FMPs, these are defined as investment firms such as asset managers. The financial products they offer include mutual funds, insurance-based investment products, private pensions among others..
SFDR is applicable to Alternative Investment Fund (AIF), portfolio managed services or Undertakings for the Collective Investment in Transferable Securities (UCITS) funds which are subject to be classified as article 6, 8 or 9 products to clearly show how sustainable a fund is.
- Article 6
- Covers funds which do not have any sustainable investments and could involve stocks excluded by the ESG.
- Article 8 (Light Green)
- Covers products that promote ‘E’ or ‘S’ whether or not the investment is made out of ESG components, or the product was not made to have an impact on the environment or society.
- Article 9 (Dark Green)
- The objective is to specifically impact ‘E’, ‘S’ or ‘G’, and the majority of the components are usually ESG investments.
What do you need to do? Timeline and Documents to be updated
- 10 March 2021
- (Level 1) SFDR comes into effect, requiring FMPs to disclose SFDR related information at an entity level (i.e, if they comply or explain why they don’t).
- 1 January 2022
- The first Taxonomy Alignment (Level 1) comes into effect, requiring additional disclosures on climate change. The Taxonomy Alignment is a guiding force to assist SFDR in identifying ‘green’ products.
- 1 January 2023
- Regulator Technical Standards Final Draft (Level 2) comes into effect. The Regulatory Technical Standard is a guidebook on how to comply with SFDR, defining terms and deadlines for all those it applies to.
- Second Reference Period (Level 2) – Second Taxonomy Alignment comes into effect, requiring additional disclosures on environmental funds. PAI disclosures at entity level and annual reporting on PAI to begin.
- 30 June 2023
- Firms that consider PAI must publish annual PAI statements (Level 2) on First Reference Period by 30 June each year on the most recent reference period.
Taxonomy Regulation
The Taxonomy Regulation is a helping force assisting the SFDR in identifying ‘green’ products. It requires additional information on the objectives set out in the SFDR. The first two objectives lie under the climate category, climate change mitigation and climate change adaption. These are considered our first Taxonomy Alignment which is due the 1 of January 2022. We also have the following four objectives:
- the sustainable use and protection of water and marine resources;
- the transition to a circular economy;
- pollution prevention and control;
- the protection and restoration of biodiversity and ecosystems.
These are considered our Second Taxonomy alignment which is due 1 January 2023. During the Taxonomy Alignments, all taxonomy related disclosures will need to be updated with this additional information.
ESG and Sustainable Finance; and the role of Europe
Europe has a large role to play here, becoming the world leader in sustainable investments and working toward a greener more sustainable future. We can already see other countries adopting the European SFDR into their strategies or using the EU SFDR as basis for their national legal frameworks such as the UK.
Non-EU investment firms are also in scope of SFDR if they have any products that are marketed in the EU, meaning non-EU firms will be required to make disclosures at the same level.
Pitfalls, things to look out for
SFDR has several pitfalls though, which we should all look out for, given that it’s still in the very early days of development and adoption. Without an industry standard of rating/scoring, inconsistency is a common issue throughout FMPs. A company can have two entirely different ESG ratings from two data providers, as currently this is down to the ESG focus of the one rating.
Data gathering is another issue, putting aside the large quantities and inconsistent data, some investee companies are not yet required to disclose certain ESG related data until later dates, although others are required to release disclosures on this data very soon which leaves a data gap.
As SFDR is still a very early life stage, one can expect through experience and learning, once a higher level of maturity has been reached, that these pitfalls will become non-issues within the next few years.
What can Prisma do
At Prisma, we can help produce and update your documentation in a professional typeset layout, as well as translating these documents into all Western, European and Asian languages.
Worried about distribution of this information across the many platforms? Don’t worry, we’ve got you covered there, too. We offer physical and digital mailing distribution and can also create websites to display your disclosures. Find out how we can help today at https://www.prisma.lu/our-services/ or contact us at https://www.prisma.lu/contact/.
