Sustainable Finance Disclosure Regulation (SFDR)
The SFDR aims to increase transparency in the investments sector in relation to sustainability. It sets out a new set of disclosure requirements applicable to financial market participants, financial advisors, and financial products. The SFDR takes a broad approach and Managers, as “financial market participants”, whether active in the environmental, social and governance (ESG) space or not, are required to comply with certain disclosure requirements relating to the integration of sustainability risks into
(i) the investment decision making process at both entity and fund level and
(ii) into the remuneration arrangements of the Manager. Additional disclosure requirements apply in respect of ESG products.
A requirement to consider principal adverse impacts on sustainability factors applies on a comply or explain basis (except for large entities for which it is mandatory. The concept of “principal adverse impacts” (PAI) is intended to capture the impact of investment decisions (and advice) that result in negative effects on sustainability factors. PAI is therefore concerned with how the activities of underlying investee companies impact on sustainability. There are requirements in relation the disclosure of PAI at the product level.
Under SFDR, financial products must fall under one of three categories and will need to meet the disclosure requirements applicable to that particular category.
EU Sustainable Finance Framework
Article 6 products
This is the default product category for funds that do not hold themselves out as ESG funds and do not meet the conditions under Articles 8 and 9. Non-ESG financial products must meet a minimum requirement relating to the integration of sustainability risks under Article 6. This applies on a comply or explain basis.
Article 8 Products
Funds falling in scope of Article 8 of the SFDR are products that promote, among other characteristics, environmental or social characteristics, or a combination of those characteristics. Examples can include:
Best in class
Exclusions of particular securities
Article 9 Products
Funds falling in scope of Article 9 of the SFDR (Dark Green Funds) are products that pursue ‘sustainable investment’ as their investment objective or which have reduction in carbon emissions as their objective. Sustainable investment is defined as an investment in an economic activity that contributes to an environmental and/or social objective provided that such investments do not significantly harm any of those objectives and that the investee companies follow good governance practice.
Managers categorising their funds as either Article 8 or Article 9 will be subject to enhanced disclosure requirements to increase transparency and inform end investors about the sustainability-related performance of those funds relative to the environmental/ social characteristics promoted or the sustainability objectives pursued.