Sustainable Finance Disclosure Regulation (SFDR)

The Sustainable Finance Disclosure Regulation (SFDR – Regulation (EU) 2019/2088) is a Regulation introduced by the European Commission to improve transparency in the market for sustainable investment products, prevent greenwashing and increase transparency around sustainability claims made by financial market participants.

It introduces mandatory information on a broad range of environmental, social & governance (ESG) metrics that Financial Market Participants (FMPs)(1) must disclose at the entity and at product level.

In particular, SFDR requires FMPs to disclose information on how they incorporate sustainability risks into their investment decision-making processes (Art. 3 I SFDR).

On the product level, SFDR distinguishes between different levels of disclosure depending on the ambitions of a certain product:

For all their financial products, FMPs have to disclose information on how they integrate sustainability risks into the investment decisions and the impacts sustainability risks may have (Art. 6 I SFDR). If FMPs deem sustainability risks as not material risks for their investments, they must disclose the reasons in the financial products’ pre-contractual documents (e.g., prospectus);
FMPs don’t have to disclose any additional sustainability-related information for those products which do not have additional characteristics linked to sustainability. These products which do not have any sustainability ambition are commonly referred to as “Art. 6 products”;
FMPs must disclose additional information – including the information on sustainability risks – for products that either “promote environmental and or social characteristics” (Art. 8 I SFDR) or have “sustainable investments as their objectives” (Art. 9 I SFDR). These products are commonly referred to respectively as “Art. 8 products” or “Art. 9 products”.

In addition, SFDR has been complemented by a set of Regulatory Technical Standards (SFDR-RTS – Commission Delegated Regulation (EU) 2022/1288), which further detail the information FMPs must disclose by introducing, amongst others, a set of disclosure templates for products promoting environmental and/or social characteristics (Art. 8 I SFDR) and for products having sustainable investments as their objective (Art. 9 I SFDR).

The SFDR-RTS also detail the concept of Principal Adverse Impacts (PAIs). PAIs are environmental and social-related indicators that assess the (negative) impacts that investment decisions taken by FMPs have on sustainability factors, such as environmental and social issues. The SFDR-RTS divide the PAI indicators into three tables, which are included in Annex I:

Table 1: Mandatory environmental and social indicators for investments in investee companies (14 indicators), sovereigns and supranationals (2 indicators), and real estate assets (2 indicators). Examples of these indicators are: GHG emissions, activities negatively affecting biodiversity-sensitive areas, and board gender diversity;
Table 2: Additional optional environmental indicators for investments in investee companies (16 indicators), sovereigns and supranationals (1 indicators), and real estate assets (5 indicators). Examples of these indicators are: emissions of air pollutants, water usage and recycling, and raw materials consumption for new construction and major renovations;
Table 3: Additional optional social indicators for investments in investee companies (17 indicators) and in sovereign and supranationals (7 indicators). Examples of these indicators are: rate of accidents, insufficient whistleblower protection, and lack of anti-corruption and anti-bribery policies.

Notes:

(1) In general, FMPs are actors that take part in the market by purchasing and offering financial assets. Amongst others, FMPs in scope are: Alternative investment fund managers (AIFMs); UCITS management companies; Investment firms; Credit institutions providing portfolio management services.

FMPs in the scope of SFDR must disclose publicly on their websites information on how they integrate sustainability risk considerations into their investment processes, as well as whether they consider adverse impacts of their investment decisions (PAIs).

In case they consider PAIs, FMPs are required to publish an overview of the impacts on their website and update the overview annually. In addition, FMPs must review their existing remuneration policies and assess the impact the integration of sustainability risks may have on those documents.

In short, SFDR requires FMPs to disclose the following information publicly on their websites:

Description of the integration of sustainability risks into the investments decision-making process (“Sustainability Risk Policy”);
Statement on the consideration of PAIs (“PAIs Statement”);
Updated remuneration policy including sustainability considerations.

Aside from the disclosures at the entity level, FMPs must disclose certain product information based on each product’s characteristics. For products that promote environmental and/or social characteristics (Art. 8 SFDR) or have investments in sustainable activities as their objective (Art. 9 SFDR), FMPs must use the disclosure templates introduced by the SFDR-RTS. The templates provide (potential) investors with information on the sustainability characteristics of a specific product prior to the investment decision (pre-contractual disclosures), as well as on the actual sustainability performance on an annual basis (periodic disclosures).

Amongst others, FMPs must explain:

What environmental and/or social characteristics a product promotes (Art.8 SFDR) or what sustainable investment objective a product pursues (Art. 9 SFDR);
What indicators are being used to measure the adherence to the promoted characteristics or to the sustainable investment objective(s);
How good governance principles are taken into account;
Whether or not a product considers PAIs;
The planned asset allocation.

In depth

Deep dive into the key characteristics of the EU sustainable finance regulation