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The financial market is undergoing a transformative shift with the introduction of a groundbreaking regulation to enhance the reporting of Environmental, Social, and Governance (ESG) factors across Europe. This regulation, known as the Sustainable Finance Disclosure Regulation (SFDR), is poised to revolutionise transparency and empower investors with better information for decision-making.

So, what exactly is the SFDR? The Sustainable Finance Disclosure Regulation is a crucial piece of EU legislation designed to standardise ESG disclosure requirements and enhance the transparency of sustainability reporting among financial market participants.

What is the Sustainable Finance Disclosure Regulation (SFDR)?

The Sustainable Finance Disclosure Regulation, commonly known as the SFDR, is a pivotal EU legislation that mandates standardised ESG disclosure requirements and increases the transparency of sustainability reporting among financial market participants.

Who is subject to the SFDR?

The SFDR applies to EU financial advisors and financial market participants (FMPs). FMPs include: 

  • Pension funds, asset managers, insurance companies, banks, venture capital funds, and credit institutions. 
  • Investment managers/advisers from outside the EU if they offer products in the European Market or oversee EU assets and funds.
  • Larger FMPs (with over 500 employees) and those considering the Principal Adverse Impacts (PAIs) must publish PAI statements annually.
  • Smaller FMPs (with fewer than 500 employees) can either adhere to the 'Comply or Explain' principle or detail why they aren't complying.

What does the SFDR require?

The SFDR mandates two levels of disclosure:

1. Entity-level reporting: Here, institutions need to disclose:

  • Sustainability risks associated with their investment processes 
  • The Principle Adverse Impacts (PAIs) or negative consequences of investment decisions 
  • How sustainability risks and ESG factors are integrated into their remuneration policies. 

2. Fund/product-level reporting: The SFDR categorises products into three distinct categories, each having its disclosure rules:

  • Article 6 products refer to funds that do not integrate sustainability factors into their investment process.
    • These must 1) disclose how sustainability risks are integrated into product investment decisions and 2) assess the likely impacts of sustainability risks on the returns of the financial products.
  • Article 8 products refer to funds that promote and integrate ESG into their investment processes.
    • These must 1) disclose the ESG characteristics promoted by the fund and how these are met, and 2) benchmark themselves against other products that promote similar characteristics.
  • Article 9 products: refer to funds with sustainable investment as their primary objective.
    • These must 1) disclose ESG fund objectives, 2) prove how the index is aligned with these objectives and the EU Taxonomy, and 3) explain how and why the designated index may differ from a broad market index.

Where and when should disclosures be made?

1. Entity-level disclosures: Institutions should present this information on their official websites, detailing their approach towards integrating sustainability risk and how ESG factors affect their decision-making processes.

2. Product-level disclosures can be pre-contractual or presented in an annual report. They must also be always accessible on the company's official website.

Reporting on Principal Adverse Impacts should be carried out annually by 30th June, referencing the preceding calendar year.

Are there any penalties?

There are no direct financial or legal penalties for not complying with the SFDR. However, firms that do not comply may face reputational damage.

Further readings

The introduction of the SFDR marks a significant stride towards transparency and accountability in the financial sector. By ensuring that institutions disclose their approaches to sustainability and the potential impacts of their investment decisions, the SFDR aims to provide investors with the tools they need to make informed choices.

The world of finance is ever-evolving, and staying informed is the key to success. Contact our policy experts to start reporting on your impact.

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