What began in the 1960s as a minuscule vote of financial conscience and remained that way until around a decade ago, has now emerged as a mighty force: ESG investing. In growing numbers, investors now act on ESG, even as they keep close watch on their returns. Indeed, the potential for financial choices to positively impact the planet matter more than ever and today’s worldwide markets are waking up to this reality.
In America, 2021 investment giant BlackRock has launched its U.S. Carbon Transition Readiness ETF. And globally, ESG funds are projected to approach £1 trillion by 2030. That would surpass £4.1 billion invested for all of 2018 by close to 200 times.
Now the question is: How can the EU encourage its financial market participants and financial advisors to invest in sustainable options? This is where Sustainable Finance Disclosure Regulation (SFDR) enters. SFDR is a solution put forward by EU’s High-Level Expert Group (HLEG) on sustainable finance.
What is SFDR?
Aligned with the European Green Deal, which aims to make the EU carbon neutral by 2050, SFDR promotes transparency for investors trying to compare and understand the sustainability profile of funds. Effective 10 March 2021 (but with the deadline for disclosure as 30 June), it integrates sustainability considerations into financial systems and directs capital flow towards such investments. Yet there’s another important consideration at work: forcing companies to avoid or eliminate the controversial practise of greenwashing.
With greenwashing, a company or organisation spends more of its resources promoting an environmentally friendly image than on minimising environmental impact. Under SFDR, sustainability information must be solid, so investors can make the most informed investment choices possible.
To that end, SFDR introduces the measurement of Principal Adverse Impacts (PAIs). They represent negative effects on sustainability factors connected to investments or investment advice. Among the PAIs considered are
- environmental, social, employee matters,
- human rights matters,
- anti-corruption factors, and
- anti-bribery factors.
Measuring these categories leads to greater transparency, reduced sustainability risks and more concrete comparisons based on sustainability levels.
What information do you need to disclose?
SFDR requires two levels of disclosure: sustainability practices (at the entity level) and financial products (on the product level). PAIs that fall under both levels must be reported, though 46 of the 64 adverse impact indicators are voluntarily shared. They cover a wide range of ESG issues from emissions to waste management, and also include fossil fuel exposure, due diligence over human rights and a company’s record on exposure to corruption.
At the entity level, SFDR requires companies to provide how they incorporate sustainability risks into the processes of making investment decisions and offering financial advice. This calls for:
- policy statements that detail how companies weigh PAIs as they relate to sustainability factors
- remuneration policies that show consistency with integration of sustainability risks
- pre-contract disclosures that address how sustainability risk is integrated
- assessments that explain how risks may affect financial product performance.
On the product level, you need to explain how financial products account for impacts in the PAIs you consider. This points to pertinent issues related to what SFDR defines as Article 8 products (which promote environmental or social characteristics) and Article 9 products (which name sustainable investments as an objective). For the former, you must provide additional information on how these characteristics are addressed; with the latter, you must show how the objective is achieved
Dates you should know?
Just as sustainability goals are phased in over time, so too are SFDR provisions and deadlines. Though the base requirements went into effect on 10 March, these are some milestones for SFDR:
- 30 June 2021: Firms with more than 500 employees must disclose PAI due diligence policies.
- January 2022: Periodic reporting begins on environmental and social characteristics, and sustainable investment objectives. This will align with the EU taxonomy on climate change mitigation and adaption objectives.
- 30 December 2022: Firms that consider PAIs must disclose how their products address impacts, while others must explain why they don’t.
- January 2023: Products that promote environmental or social characteristics and products with sustainable investments as objectives must have periodic and precontractual reporting in place in alignment with EU taxonomy objectives.
- 30 June 2023: Firms must disclose their PAI detailed indicators ranging from January to December 2022.
Managing your SFDR data
It may seem like a major challenge to gather data from multiple sources and address SFDR regulations at the same time. But when you keep all your ESG-related data in one place, you can stay organised, manage your reporting, and ensure you disclose the required information.
Rio streamlines this complex process by using our built-in ESG framework requirements, real-time data visualisation, and easy data management. We help entities set goals, collect material data consistently, and analyse/display it in a meaningful way. Meanwhile, as you consider your next steps on your SFDR journey, be sure to check out our guide to ESG reporting.
How can Rio help you? Contact us at rio.ai or schedule a meeting/send us a message.
