SFDR – a disclosure regulation
SFDR is designed to play a key role in directing much needed private capital to sustainable investments. According to EU estimates, around €350 billion are needed to finance the transition to climate neutrality. It seeks to achieve this by harmonising ESG disclosures to investors in the EU and enhancing the comparability of green financial products such as investment funds. By imposing detailed transparency rules, SFDR also seeks to tackle greenwashing – the practice of gaining an unfair competitive advantage by marketing a product as green, when in fact basic ESG standards have not been met.
In essence, SFDR requires fund managers and advisors to disclose how ESG risks are integrated into investment decisions and advice and whether or not the negative impact of investments on the environment, social and other matters, such as human rights, are being considered. SFDR requires additional disclosures for ESG products and products that have a sustainable investment objective.
SFDR requires additional disclosures for ESG products and products that have a sustainable investment objective.
SFDR has created three broad product categories: ‘Article 6 products’ which neither promote ESG nor have a sustainable investment objective; ‘Article 8 products’ which promote environmental and/or social characteristics and ‘Article 9 products’ which have a sustainable investment objective.
The asset management industry has been quick to embrace the opportunities that SFDR has provided. According to Morningstar, there were an estimated €4.05 trillion assets managed in article 8 or article 9 investment funds at the end of 2021.
One year on – the rocky road to implementation
While the proliferation of green products categorised as either article 8 or article 9 under SFDR is generally to be welcomed, it is fair to say that one year on, SFDR has not been an unqualified success when it comes to meeting its main objectives of enhancing transparency and the comparability of green products as well as fighting greenwashing.
There are several reasons for this, the main ones being the ESG data challenge and the incomplete implementation of SFDR and other sustainable finance rules.
Currently, only very few companies in the EU (around 11,000 ) are obliged to report environmental or social data. New rules extending the scope of such reporting to more companies and introducing EU sustainability reporting standards are not yet in force. This impacts what financial products subject to SFDR can currently report ending investors.
Another serious issue is the incomplete and/or delayed implementation of SFDR and other sustainable finance rules such as those on ESG reporting. Detailed rules implementing SFDR have been postponed several times by the EU Commission and are now only set to apply from 1 January 2023. This has led to legal uncertainty as to the application and interpretation of a certain number of SFDR’s disclosure rules. This uncertainty has resulted in the quality of ESG disclosures varying significantly from one product to another. Morningstar, an investment research provider, has even decided to drop certain article 8 and article 9 funds from its sustainable list due to what it calls ‘ambiguous language’ in the fund documents.
A silver lining
Getting SFDR right will be crucial in transitioning the EU to a low carbon and more sustainable future. If successful, SFDR could become the global benchmark for rules on sustainable finance.
Getting SFDR right will be crucial in transitioning the EU to a low carbon and more sustainable future.
The process is, however, likely to take several years as several pieces of the EU’s sustainable finance puzzle will need to be completed.
In the short term, it is hoped that the application of the SFDR implementing rules from 1 January 2023 will provide regulators and fund managers with more legal certainty on the SFDR disclosure requirements. The availability of better ESG data over the coming years should also help to improve the quality of disclosures to investors.
To conclude, it is important to stress that the disclosure obligations of SFDR can only achieve so much. The real test will be whether there is serious political and societal will in the EU to fully embrace the transition to a sustainable economy.
https://ec.europa.eu/info/business-economy-euro/banking-and-finance/sustainable-finance/overview-sustainable-finance_en
https://www.reuters.com/business/finance/four-every-10-euros-european-fund-assets-now-sold-sustainable-morningstar-2022-02-07/
Source: European Commission https://ec.europa.eu/commission/presscorner/detail/en/qanda_21_1806
https://www.ft.com/content/9cf8c788-6cad-4737-bc2a-2e85ac4aef7d