The Sustainable Finance Disclosure Regulation takes effect: What to expect

On 10 March 2021, the European Commission’s Sustainable Finance Disclosure Regulation  entered into force. The SFDR governs sustainability-related disclosures and applies to financial market participants (FMPs) [1]  and financial advisers (FAs) active within the European Union.

The legislation establishes harmonized rules for the disclosure of sustainability risks and opportunities related to entities’ sustainability products. The obligation to disclose the required sustainability-related information (so-called “principal adverse impacts”, or PAI) is twofold, applying at both the entity (i.e. investor) and product (i.e. fund) level.

At the product level, the SFDR has set definition criteria for funds and mandates in three categories:

• Products with sustainable investment as their specific objective. Sustainable investments are defined in the SFDR and must follow the principle of “do no significant harm.” In addition, investee companies must follow good governance practices. (Article 9)
• Products that promote environmental and/or social characteristics and only invest in companies that follow good governance practices. (Article 8)
• Out-of-scope products that do not fall into either of the above categories and are labelled as non-sustainable (Article 6)

Boosting confidence in ESG strategies

Philip Wrangberg , a senior analyst on the Responsible Investments team in Nordea Asset Management, expects that the above categorisation will help clarify product offerings in relation to client demands. He expects “significant demand for Article 8 and 9 products.”

Furthermore, the SFDR will likely advance its goal of curbing greenwashing and improving comparability via standardised sustainability disclosures.

“Investors have now received a more standardized approach to sustainability integration, which can help clients gain more confidence in ESG strategies,” Wrangberg says. However, he also sees a disconnect between the information the regulation calls for and what the market can supply.

“It is a circumstance that financial market participants must overcome and adapt to while the whole ecosystem of sustainable investing matures,” he says.

‘Period of misalignment’

The disclosed information will be visible, among other places, on the financial players’ websites, due diligence policies and relevant prospectuses.

As the March 10 implementation date fell short of providing the full spectrum of specific disclosure elements, with the Regulatory Technical Standards (RTS) not yet in force, the final version of the SFDR is expected to be delivered by January 2022. During the interim period, the practical implementation of the required disclosure elements remains a challenge.

Wrangberg characterises it as a “period of misalignment” due to market participants’ differing interpretations of the “unfinished” regulation.

[1]  If a financial market participant has less than 500 employees, the principle of “comply-or-explain” applies. Financial market participants include players such as pension funds, asset managers, banks, venture capital funds and insurance companies.