Struggling to understand SFDR Articles 6, 8 and 9?
The financial sector is facing an alphabet soup of regulations, and one of the most recent additions is the Sustainable Finance Disclosure Regulation (SFDR).
The SFDR is part of a wider trend toward increasing transparency in the financial sector, and it is expected to have a significant impact on the way that companies do business.
The EU's Sustainable Finance Disclosure Regulation (SFDR) classifies asset managers' funds as either an article 6, 8, or 9 funds depending on their level of sustainability, and regardless if they are promoting their fund as an ESG investment.
What exactly does this actually mean? In this guide, we break down what SFDR means and its implications for the financial sector.
What is the SFDR?
The Sustainable Finance Disclosure Regulation (SFDR) is a regulation of the European Union. The regulation came into effect on 10th March 2021 and is a key part of the coming EU Taxonomy Regulation.
The EU Sustainable Financial Disclosure Regulation (SFDR) is a legislation that aims to make it simpler for investors to tell and compare between the numerous sustainable investing techniques now available.
How will it help?
The SFDR will help investors make more informed decisions about where to invest their money. It will also help reduce the risk of investing in unsustainable companies or projects.
The SFDR requires asset managers and investment advisers to provide specific company-level disclosures on how they address two major matters: Sustainability Risks and Principal Adverse Impacts.
The SFDR also seeks to assist investors in selecting between funds by categorising them into three groups based on their degree of sustainability importance.
These categories correspond to Articles 6, 8 and 9 within the SFDR (more below).
In short, article 6 requires asset managers to disclose the integration of sustainability risks in their funds–regardless of whether the fund is advertised as ESG or not. Investments labelled as ESG must either be classified as an article 8 or 9 investment, depending on which classification criteria are met by their financial products.
Who is it for?
Any financial institution (no matter the size) can create a report that is aligned with the SFDR requirements.
However, the SFDR is specifically targeted at any financial market participant who offers products or services to EU investors, including asset managers, banks, and insurers.
This includes Financial Market Participants (those who create investment products e.g. VCs or Asset Managers) and Financial Advisors (those that provide advice on investments or insurance).
What do you need to know?
The SFDR requires financial institutions to disclose information about the following:
- Their sustainable finance policies and procedures;
- how they integrate sustainability risks into their investment decision-making processes;
- the proportion of their assets that are invested in sustainable projects; and
- the adverse impacts of their investment activities on sustainability factors.
Let's have a deeper look below.
What is SFDR Article 6?
Article 6: Transparency of the integration of sustainability risks
In short: If your product isn't advertised as a sustainable investment, Article 6 still requires you to show how you integrate ESG factors into the decision-making process or explain why sustainability risk isn't relevant.
Even if a fund deems sustainability risks not to be relevant, it must clearly state why. SFDR Article 6 requires financial market participants to include descriptions of the following in pre-contractual disclosures:
- The process for identifying, managing and disclosing sustainability risks;
- Provide a disclosure policy on how to identify these risks;
- Describe how their policy will be achieved and the results to date.
What is SFDR Article 8?
Article 8: Transparency of the promotion of environmental or social characteristics in pre‐contractual disclosures.
In short: these are products that promote environmental factors but don't have sustainable investing as their core objective.
Article 8 requires the following:
- A fund intending to promote environmental or social characteristics must make these intentions clear in its pre-contractual disclosures.
- The fund manager must explain how the chosen strategy will help achieve the desired environmental or social outcomes.
- The fund's annual report must disclose information on the outcomes achieved and how they relate to the fund's stated objectives.
This article is important because it ensures that investors are aware of a fund's ESG objectives and that they can hold the fund manager accountable for achieving those objectives.
The fund must also disclose the methodology that has been used. Ultimately, this helps to create a more sustainable and responsible investing environment.
What is SFDR Article 9?
Article 9: Transparency of sustainable investments in pre‐contractual disclosures
In short: these are products that have sustainability factors and sustainable investment as their core focus.
SFDR Article 9 requires financial firms to provide comprehensive and understandable disclosures relating to sustainable investments prior to entering into a contract with a client.
In comparison to Article 8, this includes information on the nature of the investment, the sustainability objectives pursued, the likely impacts of the investment on those objectives, and how those impacts are assessed.
SFDR Article 9 also requires firms to state if they have an objective of reducing the overall carbon footprint.
Financial firms must take steps to ensure that their disclosures comply with SFDR Article 9 in order to avoid any legal or reputational risks.
What are the timelines and what needs to be disclosed?
The requirement of a Principal Adverse Impact (PAI) indicator is one of the most significant consequences of the SFDR. All financial market participants must disclose 14 required indicators and two extra metrics (i.e., from the environmental and social tables) for public equity (PE) investments at an entity level in accordance with the regulation.
These are some of the climate indicators that need to be disclosed:
- GHG emissions
- Carbon footprint
- GHG intensity of investee companies
- Exposure to companies active in the fossil fuel sector
- Energy consumption intensity
- Emissions to water
- Hazardous waste ratio
Key dates to be aware of:
- Jan 2022 - Latest date by which those with more than 500 employees must start considering Principle Adverse Impacts (PAI)
- Jan 2023 - Earliest date to disclose Principle Adverse Impacts
- Dec 2023 - Latest date to disclose Principle Adverse Impacts.
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