The EU regulation that came into force on 10 March requires extensive disclosures from financial market participants. Read on to find out more
by Bethan Rees
The EU's Sustainable Finance Disclosure Regulation (SFDR) has been in force since 10 March and "applies to financial market participants (FMPs) whose business is in Europe, non-EU FMPs (and their subsidiaries) who do business in the EU or sell products to the EU, and non-EU firms that sub-manage EU assets or funds", according to a 2021 report on SFDR by Sustainalize, a Netherlands-based consulting and interim-management firm specialising in sustainability.
Here are five things to know about SFDR, drawn from CISI webinars on the subject.
The background
In a CISI TV webinar titled From SFTR to SFDR on 10 February 2021, Farrah Mahmood, senior regulatory analyst at the International Securities Lending Association, provides some context to SFDR, saying that it goes back to 2016, when the European Commission established a high-level expert group on sustainable finance.
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"The group's core mandate was to advise the commission on how to mainstream sustainability into risk management," she says. Recommendations of the group were used to form the 2018 Action plan: financing sustainable growth, with action seven of the ten actions "calling for clarification of asset managers and institutional investors’ duties regarding sustainability and a proposal for the regulation on disclosures on sustainable activity". In 2019, co-legislators adopted SFDR as it is today.
Its purpose
Article 1 of the regulation "lays down harmonised rules for financial market participants and financial advisers on transparency with regard to the integration of sustainability risks and the consideration of adverse sustainability impacts in their processes and the provision of sustainability‐related information with respect to financial products".
Mahmood explains in From SFTR to SFDR that one of the main purposes of SFDR is "to address concerns that disclosures are currently inconsistent across the market, which make it difficult for end investors to compare and make informed investment decisions".
"In-scope firms are required to publish written policies on the integration of sustainability risk into their investment decision processes. They are required to make contractual disclosures on how they incorporate these risks into their businesses or product, as well as publish an online description on their website on the methodologies used to assess and to evaluate the effectiveness of investments," she says.
Who does it impact?
The application is broad, says Barry O'Connor, partner, asset management and investment funds at Irish law firm Matheson, in a CISI TV February 2021 webinar titled SFDR – what does it mean for the manager and the investor? He explains that the regulation covers FMPs – essentially anybody that is engaged in portfolio management, including insurance companies, undertakings for collective investment in transferable securities, alternative investment managers, and financial advisers.
In From SFTR to SFDR, Mahmood says that it will also impact investment firms that are subject to the Markets in Financial Instruments Directive reporting for portfolio management services in respect of how they integrate sustainability risk into their investment decisions.
Mahmood says it's important to note that even if an in-scope firm does not offer an environmental, social and governance focused product, it may still be captured by this regulation.
Article 6, 8 and 9 product categories and pre-contract disclosures
Under SFDR, different product categories require additional pre-contractual reporting. In SFDR – what does it mean for the manager and the investor? Louise Dobbyn, partner, financial institutions group at Matheson, explains the difference between article 6, 8 and 9 categories.
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Article 6 disclosures apply to all products. FMPs must disclose whether sustainability risks are integrated into their investment decisions, and the likely impact of the sustainability risks on those products.
Article 8 disclosures apply to products often referred to as 'light green products', which promote environmental or social characteristics, or a combination of the two. Firms must disclose which characteristics the products meet, and how the product meets them, Dobbyn says.
Article 9 disclosures apply to products often referred to as 'dark green products' that have sustainable investment as their objective. Dobbyn says that SFDR "defines sustainable investment as investments in economic activity that contribute to an environmental objective, a social objective or investment in human capital or socially disadvantaged communities. Firms must disclose how sustainable investment objectives are being met," she says.
Good governance requirement
Under the regulation, to ensure consistent application, "it is necessary to lay down a harmonised definition of ‘sustainable investment’ which provides that the investee companies follow good governance practices and the precautionary principle of ‘do no significant harm’ is ensured, so that neither the environmental nor the social objective is significantly harmed."
In a Columbia Law School blog, Michelle Kirschner, Chris Hickey and Martin Coombes say that "'good governance practices' is not defined in the SFDR. It is clear from the text that the European legislators intended it to be interpreted widely".
In SFDR – what does it mean for the manager and the investor? Sam Tripuraneni, lead product strategist for commercialising BlackRock Sustainable Investing's IP in EMEA, explains that good governance practices include sound management structure, employee remuneration, employee relations and tax compliance.