Regulatory Overview of SFDR

SFDR

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The SFDR (1) requires financial service companies to provide information about how they consider sustainability risks and how their products perform. This has the goal to provide investors with the transparency needed to assess assets and ultimately support the financing of sustainable growth while preventing greenwashing.

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The SFRD applies to financial market participants such as investment firms providing portfolio management and financial advisors such as insurance intermediaries. The SFDR came into force in March 2021 and disclosure requirements were phased in between then and June 2023.

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Disclosures are required at the entity level as well as the (financial) product level. On both levels, companies report on two types of metrics in alignment with the principle of double materiality: sustainability risks which may impact the value of the investment and Principle Adverse Impacts (PAI) which measure negative impacts of investments on the environment and people. Financial advisers are exempt from reporting PAIs on a product level.

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At the entity level, companies must disclose their policies on the integration of sustainability risks (article 3). Furthermore, they must be transparent about whether they consider PAIs of investment decisions (article 4). Companies with less than 500 employees can choose between reporting PAIs or explaining their choice to not do so (“comply or explain”).

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At the product level, pre‐contractual disclosures have to state how sustainability risks were considered and to include information on likely impacts of sustainability risks on the returns of the financial products. Financial institutions must categorize their investment products into the following three categories which have increasingly stringent disclosure requirements:

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1) products without sustainable characteristics (article 6)

2) products with a sustainable focus, also called “light green” (article 8)

3) products with specific sustainability objectives, also called “dark green” (article 9)

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For article 6 products, which is the default, requires only disclosure of the integration of sustainability risks. For article 8 and 9 products, there are requirements to demonstrate how they contribute to and do not undermine ESG objectives in accordance with the EU Taxonomy.

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There are mandatory and voluntary PAI across the topics environmental, social, and governance (ESG). Climate change is again a key component. Among the mandatory PAI are emissions-related metrics such as Scope 1, 2, and 3 GHG emissions and the share of non-renewable energy consumption and production. This information is collected as part of the due diligence process. SFDR lets companies leverage different types of data sources e.g., company disclosures as well as using estimates but requires them to publish details on their approach.

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Sources

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1 https://finance.ec.europa.eu/sustainable-finance/disclosures/sustainability-related-disclosure-financial-services-sector_en

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