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26 Feb EU SFDR Has Arrived: What it Means for All Investment Managers & Advisors
2. provide advisory services to EU asset managers or asset owners;
3. market and sell fund products (including Cayman) or advisory services in EU.
The European Commission published the regulation on sustainability-related disclosures in the financial services sector on December 9, 2019, which is known as the Sustainable Finance Disclosure Regulation (SFDR) and is going into effect on March 10, 2021. In parallel to the implementation of SFDR, the European Supervisory Authorities (ESAs) also issued the draft Regulatory Technical Standards (RTS) on February 2, 2021, as a supplement. The RTS specifies disclosure content, methodologies, and presentation at both entity and product levels under the SFDR for investment firms and their products and services, which will come into force on January 1, 2022.
The precautionary principle of sustainable investments under the SFDR is to ‘do no significant harm’ towards environmental sustainability. In general, the disclosure requirements consist of four parts:
Disclosure requirements and timeline
The SFDR lists the scopes of financial market participants (FMP), financial advisers, and financial products that are subject to the regulation:
Although the SFDR divides financial entities into two types, at the corporate level, it requires both FMPs and financial advisers to consider PAI of investments, with an initial requirement of ‘comply or explain’.
As for differences, notably, reporting PAI on sustainability factors of their investments is mandatory for large-sized FMPs that have more than 500 employees since the official launch of the SFDR this March. Large FMPs must update the principal adverse sustainability impacts statement on their websites by June 30 each year with the previous calendar year as the reference period. Their first reporting is scheduled for June 30, 2022, with the first reference period from March 10, 2021, to December 31, 2021.
Later, the RTS, effect from January 1, 2022, will bring further specified requirements and templates for disclosures. FMPs and financial advisers will need to publish and maintain a statement of principal adverse sustainability impacts on their websites. The disclosure frequency and schedule are the same as that of large FMPs, which means their first reporting date based on the RTS is by June 30, 2023. RTS provides a template for the principal adverse sustainability impact disclosures, which includes 18 mandatory indicators for FMPs to explain, along with a total of 46 additional indicators for disclosure options. As for financial advisers, the report requirements are less than FMPs but they also have to disclose related sustainability information of the products and practices they give advice to.
In addition, if they do not consider PAI, FMPs and financial advisers will need to provide their ‘No consideration of sustainability adverse impacts’ statements.
For financial products, the reporting requirements mainly include pre-contractual, periodic, and website disclosures. Expanding from the basic disclosure requirements under the SFDR, the RTS provides four templates for the pre-contractual and periodic disclosures at the products level, in the form of question lists, designed respectively for financial products that promote environmental and/or social characteristics or have sustainable investments as their objectives.
Moreover, FMPs should disclose the impacts of the top investments of their financial products in the periodic statements, with the number of up to 15, which account for the largest proportion of their investments during the reference period. For this part, FMPs also need to publish a historical comparison report of their periodic reports for at least five previous reference periods.
For non-ESG related financial products, the newly released RTS final report also asks companies to specify that those products do not take the EU criteria for environmental sustainability into consideration.
In addition to publishing those designed reports on their websites, FMPs also need to make other website disclosures in accordance with the SFDR and RTS provisions under the section title, ‘Sustainability-related disclosures’. This aims to provide additional details of financial products, such as investment strategy.
SFDR has introduced the above disclosure requirements at both product level as well as the overall financial institution level, aiming to improve the transparency of investment firms’ products and financial advisers’ services. Along with the Non-Financial Reporting Directive (NFRD) announced in 2014 and the Taxonomy released in June 2020, this marks the EU’s efforts to promote capital flowing into environmentally sustainable projects and investments, as well as to curb fictitious green projects, an example of so-called greenwashing. This may also signal a trend in the global green development and investment sectors.
EU is one of the world’s largest economies, containing 27 countries. The implementation of the SFDR and the future RTS will not only impact EU entities, but will also impose pressure on companies and financial institutions outside of the EU.
1. Non-EU companies: those that have subsidiaries and businesses in the EU should follow the SFDR disclosure requirements similarly as EU companies. This means they would also need to provide the principal adverse sustainability impact statements, pre-contractual and periodic reports, and additional information on their websites in accordance with the regulations.
2. Non-EU investment firms: those that are now offering or plan to offer registered financial products in the EU, will need to make product-level disclosures as mentioned above. Notably, even if a company thinks its product is non ESG related, it should also explain why the product is not relevant to sustainability risks.
3. Non-EU financial advisers: those that are now offering or plan to offer investment advice to EU firms are indirectly subject to the SFDR. Since the SFDR is mandatory to EU financial and non-financial entities, they may choose service providers, either EU or non-EU financial service providers, that could make commitments to help them to comply with the regulatory requirements and obligations. Based on this consideration, non-EU financial advisers should also obey the SFDR requirements when making investment advice to EU clients.
From a broader perspective, it is anticipated that such EU regulations will lead the development of similar sustainability disclosure policies in other regions and countries around the world, as Singapore and South Korea have considered building their local green investment taxonomy. This implies that even a company thinks that it will not have connections with the EU, it may still need to take the SFDR, the Taxonomy, and others into account.
Seneca ESG provides advisory services and software solutions for compliance with the SFDR and other regulations. For more information, please contact us at firstname.lastname@example.org.