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An introduction to the Sustainable Finance Disclosure Regulation

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BNP Paribas Asset Management
 

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This material is intended for Institutional Investors (as defined in the Securities and Futures Act, Chapter 289 of Singapore) only and is not suitable or intended for persons who do not qualify as such.

The Sustainable Finance Disclosure Regulation is a central plank of the European Commission’s 2018 Action Plan for financing sustainable growth. The SFDR provides greater transparency on the degree of sustainability of financial products. The objective is to channel private investment towards sustainable investing while preventing ‘greenwashing’. The regulation will be phased in from 10 March 2021.

What is the purpose of SFDR?  

It is part of a broad package of legislative tools designed to reorient capital towards more sustainable businesses. The main objective is to ensure that financial market participants are able to finance growth in a sustainable manner over the long term, while combating so-called greenwashing in which the positive environmental claims of an investment could be untrue.

A key part of this regulation is linked to transparency, explaining how the manager of a financial product takes sustainability risks and adverse impacts on sustainability into account. There are both entity and product level requirements.

The SFDR defines and introduces transparency requirements on financial products’ characteristics such that they can be compared in the basis of their degree of sustainability. They include:

  • Consideration of sustainability risks, these being the risk of depreciation in the value of underlying assets due to environmental or social events
  • Sustainable investments in economic activities that contribute to environmental or social objectives. They include investments in EU-taxonomy eligible economic activities;
  • Consideration of principal adverse impacts (PAI) on sustainability factors; these are the negative effects on environmental, social and employee matters as well as respect for human rights, anti-corruption and anti-bribery resulting from an investment decision.

What is the scope of SFDR? 

Financial market participants are defined as investment firms, including asset managers which offer portfolio management services, pension providers, and insurance-based investors, as well as qualifying venture capital and social entrepreneurship activities.

In-scope financial products include investment and mutual funds, insurance-based investment products, private and occupational pensions, and both insurance and investment advice. If any of these products involve sustainable investments, the manager should disclose how those investments comply with the ‘do no significant harm’ principle laid out in the regulation.

From 10 March 2021, all in-scope financial products will have to disclose in pre-contractual documents information on whether and how they consider sustainability risks. Product manufacturers and advisers will have to disclose information on the integration of sustainability risks in investment decision-making or the investment advice process, as well as information on how remuneration policies are consistent with the integration of sustainability risks.

Financial products ‘promoting ESG characteristics’ or ‘investing in sustainable investments’ will have to disclose in pre-contractual documents and periodic reports information detailing these characteristics or investment objectives and explain how they have been attained.

Large product manufacturers (those with 500 or more employees) will have to disclose, at the entity level, their due diligence and engagement policies regarding the consideration of PAI arising from sustainability factors and, from 1 January 2023, for each product they manage.

Implications for investors

Financial products that do not claim to achieve any degree of sustainability may face distribution difficulties as they will have to clearly disclose that they consider neither sustainability risks, nor PAI on sustainability factors, nor EU taxonomy criteria that define environmentally sustainable economic activities.

Furthermore, under MIFID II amendments to be adopted by the end of the first quarter of 2021, such products would no longer be eligible for advice to clients that have expressed ESG preferences.

The difficulty of implementing SFRD requirements for investment products that consider sustainability issues will depend on the availability of the ESG data that will be required by the Regulatory Technical Standards (RTS) supplementing the regulation and the obligation for asset managers to make this ESG data publicly available.

The European Commission has postponed the entry into application of the RTS until a later date. Nevertheless, expertise in the ESG area and access to ESG data will be needed from 10 March 2021 to meet the principle-based requirements of the regulation while not publishing misleading information.

BNP Paribas Asset Management’s view

We believe that our fiduciary duty is aligned with sustainable investment and that we have a duty to our clients to make well-informed investment decisions: ESG (environment, social and governance) factors are a key element of this.

We seek to consider the sustainability-related preferences of our clients and to minimise the adverse impacts of our investments by using our investments, our voice and our leverage to help shape a better future.

As a long-term investor, we understand that a sustainable economic future relies on sustainable investment practices: we have both an opportunity and obligation to take action to help achieve the UN Sustainable Development Goals and the Paris Agreement. We fully support the EU’s carbon neutrality objective alongside the environmental and social objectives in the EU Green Deal.

The SFDR regulation sets common standards for disclosure. This means that investors are better informed and able to compare what is fast becoming a complex offering.

We believe the new disclosure obligations both improve investor understanding of sustainable products and reduce the risk of greenwashing.

One issue for asset managers is that they are required to access ESG data that may not be made publicly available by the companies in which they are investing. This issue could be solved by the adoption of a legislative proposal in the third quarter of 2021 to create a European Single Access Point for all relevant information including sustainability. It is important to note that all information would be provided in comparable digital formats.

Key dates 

29 December 2019 – Entry into force

31 January 2021 – Finalisation of draft ESAs RTS on PAI indicators to be disclosed by product manufacturers with 500+ employees and pre-contractual and periodic information to be disclosed on financial products promoting ESG factors or investing in sustainable investments

10 March 2021 – Entry into force of the Sustainable Finance Disclosures Regulation. Asset managers are required to define entity-level ESG policies and make ESG disclosures in pre-contractual documents

30 June 2021 – The date by which a large financial market participant can start to report. They must publish a statement on their website describing the policies in place to assess principal adverse sustainability impacts and any actions taken to address these impacts

1 January 2022 – First deadline for asset managers to submit annual product-level ESG disclosures in line with the SFDR

Asset managers required to report on climate change mitigation and adaptation in line with the EU taxonomy

1 January 2023 – Disclosure of consideration of adverse sustainability impacts financial products

* Source: Regulation (EU) 2019/2088


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Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice.

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

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This material is produced for information purposes only and does not constitute: 1. an offer to buy nor a solicitation to sell, nor shall it form the basis of or be relied upon in connection with any contract or commitment whatsoever or 2. investment advice. It does not have any regards to the specific investment objectives, financial situation or particular needs of any person. Investors should seek independent professional advice before investing, or in the absence thereof, he/she should consider whether the investments are suitable for him/her.

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