The Sustainable Finance Disclosure Regulation (SFDR) – entered into force on March 10, 2021 – brings us ever closer to the goals set by the EU on sustainability disclosure in the financial sector. The SFDR aims to increase the transparency of how financial market participants integrate sustainability (environmental, social and governance – ESG) risks and opportunities into their investment decisions.

Implications for the financial market

It also introduces a rating system with new transparency requirements for certain financial products, with significant implications for the financial market. The EU Taxonomy provides for a common classification of economic activities significantly contributing to environmental objectives, using science-based criteria.

At a national level, SFDR is introduced and supplemented in sector-specific legislation with respect to financial entities subject to the provisions of the SFDR Regulation, including investment fund managers, certain insurers, certain credit institutions, insurance brokers, investment advisors. Amendments and additions to the legislation require financial entities to comply with the SFDR and provide penalties for non-compliance. Within the scope of the SFDR fall market participants that create and distribute financial products, as well as public interest entities with an average of more than 500 employees.

Comply or explain criteria

Market participants that exceed the criterion of an average number of 500 employees (individual and consolidated at group level) must publish an up to date statement on their website, regarding their due diligence policy and the main negative effects of investment decisions on sustainability factors. Entities with an average number of employees of less than 500 apply the “comply or explain” principle. Thus, if they do not take into account the negative impacts of investment decisions on sustainability factors, they can explain this, providing reasons and information on when and why they do not intend to take such negative impacts into account.

New reporting requirements have been introduced at both the entity and product levels and focus on three aspects:

• Integration of sustainability risks;
• Main adverse impacts of investments on sustainability;
• The extent to which ESG features are integrated into financial products.

Detailed information on these aspects should be present in internal policies, on the website, in pre-contractual documents (e.g. in the investment prospectus for investment funds) or in annual reports. The most visible effect of the SFDR is the classification of financial products according to ESG ambitions. For example, the regulation provides for 3 types of financial products that entail differentiated reporting requirements, as follows:

• Article 8: Financial products of an environmentally or socially responsible nature;
• Article 9: Financial products aimed at sustainable investments;
• Article 6: All other products.

The EU taxonomy provides uniform reporting requirements and criteria on the basis of which an economic activity is considered sustainable.

The Reporting Technical Standards (RTS) provides for a further classification and differentiation of information provision and technical recording thereof. Based on the RTS, market participants that promote environmental or social characteristics or that have sustainable investment as an objective will have to provide more comprehensive information, including how much of the financial investments that these products promote are in compliance with the Taxonomy.

In short, the SFDR is a benchmark for investors interested in ESG issues and raises the bar for funds claiming to be green.