EU Sustainable Finance Disclosure Regulation

The EU Sustainable Finance Disclosure Regulation (SFDR) was developed to improve transparency, reduce greenwashing and direct capital towards more sustainable investments/ products and businesses. The hope is that this provides a more comparable approach to understanding sustainability within financial markets. 

Following the launch of Level 1 requirements going into effect in March 2021, Level 2 requirements also came into effect on 1 January 2023. Firms now have until 30 June 2023 to make their SFDR disclosures with the requirement then recurring on an annual basis.  

What is the EU Sustainable Finance Disclosure Regulation?

The SFDR is a new regulation requiring financial service providers and owners of financial products to assess and disclose environmental, social, and governance (ESG) considerations publicly.

Who does SFDR apply to?

The regulation applies to all financial market participants (“FMPs”) and financial advisors (“FAs”) in the EU, FMPs with EU shareholders, and those marketing themselves in the EU, and sets out clear disclosure requirements.

FMPs include:

  • An insurance company that makes available an insurance-based investment product
  • Investment firms that provide portfolio management
  • An institution for occupational retirement provision
  • A manufacturer of pension products
  • An alternative investment fund manager
  • A pan-European personal pension product provider
  •  manager of a qualifying venture capital fund
  • A manager of a qualifying social entrepreneurship fund
  • A management company for UCITS (Undertakings for the Collective Investments in Transferable Securities)
  • A credit institution that provides portfolio management

The products that it encompasses include (not exhaustive): investment and mutual funds, UCITS, insurance-based investment products, private and occupational pensions and insurance and investment advice.

What must firms disclose?

The SFDR disclosure obligations are divided into three categories:

1. The adverse impacts of investment decisions on sustainability factors

Obligated firms must disclose the potentially negative consequences an investment decision may have on sustainability factors and how they are mitigating the impacts. These sustainability factors include environmental aspects, such as energy performance and water usage, as well as social aspects like employee matters and respect for human rights.

One example of an environmental aspect that firms will need to disclose is biodiversity. Firms will need to demonstrate that the economic activity is not negatively affecting biodiversity-sensitive areas (through demonstrative evidence of ecological assessments, due diligence, and continual monitoring of any impacts – positive or negative).

2. Considering sustainability (ESG) risk in investment processes

Firms need to disclose where an ESG event could negatively impact material investment and align their remuneration policies with sustainability risk management.

3. Provision of sustainability information with respect to financial products

Where a product is categorised as an Article 8 or Article 9 product (see below), additional disclosures need to be made.

Classification of Products

SFDR distinguishes between three types of product classification:

Article 6Products that do not integrate ESG considerations into the investment decision-making process or explain where the integration is not relevant, where products do not meet the criteria of Article 8 or 9.
Article 8Products that promote environmental and/or social characteristics amongst other characteristics and the companies in which the investments are made have good governance practices. This implies that ESG investing is not core to these products.
Article 9Products that have sustainable investment as their core objective.

The SFDR has 2 levels of disclosure:

  • Entity Level: disclosure obligations for the entities themselves concerning their policies on decision-making on sustainability risks.
  • Product Level: reporting obligations concerning the financial products and their sustainability risks.

Entity-Level Disclosure Requirements

The SFDR sets out requirements for FMPs and FAs to disclose sustainability information at the legal entity level. When FMPS and FAs disclose, they will be required to provide policies detailing how they will integrate sustainability risk into the investment decision-making process, information and considerations on adverse sustainability impacts, and consistency of remuneration policies with sustainability risks. A firm must publish a statement of intent on their website to demonstrate which Article they intend to align to.

SFDR sets out that FMPs shall publish and maintain their policies for due diligence over the adverse impacts of their investment decisions on sustainability factors on their websites.

There are also four narrative disclosures required at the entity level on the website:

  • Information on policies to identify and prioritise Principal Adverse Impacts (“PAI”)
  • A description of such impacts and any actions taken, next steps or targets
  • Summaries of engagement policies regarding the prevention and management of potential conflicts of interests
  • Reference to responsible business conduct codes and standards for due diligence, reporting and good governance  

Per the draft Level 2 RTS (Regulatory Technical Standards), this also includes disclosure against a possible 64 quantitative ESG metrics (14 mandatory), which is likely to be a significant amount of work for many FMPs.

Environmental IndicatorsSocial Indicators
– Total GHG Emissions inc. Scopes 1,2&3
– Carbon Footprint
– GHG intensity of investee companies
– Share of investments in companies active in the fossil fuel sector
– Share of non-renewable energy consumption and non-renewable energy production of investee companies
– Energy consumption of revenue of investee companies
– Share of investments in investee companies with sites or operations location in or near to biodiversity-sensitive areas where activities of those investee companies negatively affect those areas
– Tonnes of emissions to water generated by investee companies
– Tonnes of hazardous waste generated by investee companies
– Share of investments in investee companies that have been involved in violations of the UNGC principles or OECD Guidelines for Multinational Enterprises
– Share of investments in investee companies without policies to monitor compliance with the UNGC principles or OECD Guidelines for Multinational Enterprises or grievance/complaints handling mechanisms to address violations of the UNGC principles or OECD Guidelines for Multinational Enterprises
– Average unadjusted gender pay gap of investee companies
– Share on investments in investee companies involved in the manufacture or selling of controversial weapons

Product-Level Disclosures

Product-level disclosures centre around the following areas for products covered by Articles 6, 8 and 9:

Pre-contractual disclosures cover similar areas to the entity-level disclosures around the integration of sustainability risks and principal adverse impacts, e.g. through contractual documentation, but include also additional disclosures for Article 8 and 9 products.

Periodic reporting:

  • For all products, there must be a disclosure of the principal adverse impacts on sustainability factors.
  • Additionally, there are more sustainability disclosures for Article 8 and 9 products concerning the extent to which environmental and social characteristics are met and a comparison between the product impact and the impacts of a designated index.
  • There are also requirements for green taxonomy-related disclosures for Article 8 and 9 products looking at the criterion do no significant harm (“DNSH”) and taxonomy objectives.
  • To strengthen the comparability of information to be disclosed, investors should determine PAIs on at least 4 specific dates during the reference period and disclose the average on an annual basis (Regulation 2022/1288 (5)). 

Website product disclosures – For each product under Articles 8 and 9, the entity must disclose its characteristics, how the characteristics are measured and monitored, due diligence on the underlying assets, data sources and any limitations met.

With the breadth and depth of disclosure needed at the entity level and product level, it should be possible to understand which products are sustainable and which are not. However, the latest update to the green Taxonomy and the implementation of the SFDR Regulatory Technical Standard have faced much criticism. This came after the publication of the EU Commission’s Q&A document (dated 17th November 2022) which resulted in hundreds of investment funds degrading from Article 9 to Article 8 due to clarifications upon data requirements, methodologies, evidence requirements, and guidance about what terminology could or could not be used to describe investments.  

What is the impact of the regulation?

The regulation aims to reduce greenwashing and the overstating of green credentials. Not only will the SFDR help organisations to focus on ESG risks during the investment process, but in addressing an existing gap in mandatory rules for ESG disclosure, the SFDR aim to spark a behavioural change for FMPs.

The SFDR follows a wave of new policies preserving investor value by stimulating greater investment in ESG disclosure. With 2020 proving that organisations with strong sustainability credentials can significantly outperform conventional funds during shocks, the focus on legitimising green credentials can be seen as a vital push to protect revenues and asset values from future disruption. This also follows a broader cultural shift, with climate policy being a key point in the 2020 US election and ESG risks at the forefront of investors’ minds following the shocks felt from the COVID-19 pandemic.

sfdr overlap

The SFDR sit as a gateway to further ESG-related legislative activity as part of the European Commission’s Sustainable Finance Action Plan. This includes complementing the EU Taxonomy Regulation, which looks to establish whether an economic activity is environmentally sustainable.

When complying with obligations for financial products under the SFDR, this activates disclosure requirements from the taxonomy. Similarly, firms must follow the taxonomy regulation to comply with the SFDR. The SFDR also overlaps with the EU Regulatory Technical Standards (RTS), which supplement the SFDR, albeit these have currently been delayed and are now expected in 2022.

Implementation Considerations for FMPs and FAs

For FMPs and FAs that operate in the EU to be able to market investments as Article 8 or 9, they will need to review the whole lifecycle of their products, from initial product development, marketing, contracting, through to monitoring and reporting and update their policies and processes.

In short, we see the following areas that need to be addressed:

Update the policies in place to cover sustainability risks and principal adverse impacts.
1. Review all current investment products and allocate to product classifications under Articles 6, 8 and 9. Document all product assessments that fit the criteria for Articles 8 and 9.2. Update all policies and processes for new fund set-up or new product development to ensure alignment with product classification under SFDR.

3. Have clear checklists and process steps for each type of investment/product.

4. Develop clear product risk and principal adverse impacts (PAI) disclosures for each product where applicable.

5. Disclose whether a specific index has been designated as a reference benchmark, and if so, explain what the alignment with the sustainable investment objective of the fund is.

6. For Article 9 only and if aiming to reduce carbon emissions, disclose whether the EU Climate Benchmark is a reference indicator or an EU Paris-Aligned benchmark, and if it is not, explain how the fund seeks to make a continued effort to attain the objective of reducing carbon emissions.

1. Review the current due diligence process for investing in new products and update for SFDR requirements, including data requests from issuers.2. Update research checklists and processes on investments include ESG considerations.

For assets where the FMP engages with the issuer, new requirements for data will be needed: data requests, storage of information received, inclusion in decision-making documentation.
1. Ensure there is an overall risk management policy and framework for ESG and SFDR within the business.

2. Update risk management policies and procedures for SFDR considerations concerning sustainability risks and PAIs.

3. Ensure metrics at the fund and investment level are reviewed regularly.

Develop a solution to gather and store the information needed for the policies outlined above and for disclosure requirements. Ensure capability to manage, monitor and report.
1. Benchmark existing disclosures and perform a gap analysis between current the position and SFDR requirements; outline how to close the gaps and prepare an implementation plan.

2. Ensure that disclosure requirements are built into pre-contractual documentation, marketing documentation and website disclosures.

Anthesis’ Sustainable Finance Team can provide support to your firm through the development of an SFDR framework, roadmap to disclosure, and relevant reporting templates to support your PAI data collection process. We can also undertake EU Taxonomy aligned workstreams to support the evidencing of do no significant harm (‘DNSH’) criteria, PAI calculations, and broader disclosure support. Our experience with banking institutions and fund managers also enables us to incorporate the requirements of the SFDR into due diligence tools for private equity firms and develop SFDR screening frameworks for firms to assess and evidence the entity and product-level impact against PAIs. 

To ensure your SFDR strategy aligns to your broader ESG or Investment strategy we can help to align corporate sustainability and private equity strategy against the ever-changing landscape of standards and regulations. This can involve an assessment of materiality, benchmarking, and peer reviews, as well as ESG metrics and KPI setting and annual report writing.  

We are also conducting climate risk assessments for corporates and private equity clients to help them align with the requirements of EU Taxonomy climate criteria in addition to the Task Force on Climate Related Disclosures. 

Frequently Asked Questions

The SFDR was not retained in UK law during the Brexit process. However, a UK-specific regulation is planned, which is expected to work similarly to the EU SFDR.

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