How to get ready for the SFDR’s regulatory technical standards for fund managers
Environmental, social, and governance issues are now a top concern for regulators as well as investors. The EU has concentrated on encouraging private investments in sustainable finance in recent years, starting with taxonomy regulation to more precisely identify sustainable activities. Additionally, it is establishing benchmarks for climate change and creating eco-labels for financial products.
The centrepiece of the EU’s effort toward sustainable finance is the Sustainable Finance Disclosure Regulation, or SFDR. The SFDR was approved by the European Commission in 2019. The regulation became effective in 2021, but it took the commission more than a year to complete the regulatory technical standards (RTS), which specify how funds can fulfil the requirements outlined in both the SFDR and the EU Taxonomy Regulation. The RTS was approved by the commission in April 2022, and it becomes effective on January 1, 2023.
Fund managers must take proactive measures in this dynamic regulatory environment to lower their firms’ compliance risks, ensure that their investments and investing procedures adhere to sustainability standards, and fulfil the disclosure and reporting requirements set forth by EU regulators.
Here are some important tips for fund managers as they navigate this complex and dynamic environment.
Understanding SFDR as we move toward sustainable financing
A number of high-level duties are included in the SFDR for funds that are involved in ESG or want to incorporate it into their investment procedures.
These requirements include disclosing information at the product and entity levels that categorise a fund as sustainable (according to Article 9 of the rule), partially sustainable (According to Article 8), or not sustainable (Article 6). These disclosures are intended to assist investors in making better allocation decisions, particularly for those looking to invest according to ESG principles. The legislation also tries to stop “greenwashing,” which has led to investments being misclassified intentionally or unintentionally as meeting ESG criteria.
The SFDR requires businesses to disclose the following at the entity level:
- Information on how they take sustainability concerns into account when making investment or financial advise decisions.
- A statement outlining their approach to taking main adverse impacts (PAIs) on sustainability aspects into account.
- Information on how their remuneration practises fit with taking sustainability risks into account.
- Assessments of how ESG risk may impact the performance of financial goods are included in pre-contractual disclosures for how sustainability risk is included into their processes.
In terms of specific products, the SFDR mandates that businesses divulge and offer:
- A description of how their financial products take PAI indicators into account.
- For products covered by Article 8, additional information is provided that explains how they support environmental or social values and how they adhere to the EU Taxonomy Regulation.
- A description of Article 9 items that explains how they satisfy sustainable investment goals and how they adhere to the EU Taxonomy Regulation.
The SFDR covers disclosures made prior to a contract being signed as well as disclosures made in reports, marketing materials, and websites. Fund managers, though, weren’t always sure how they should share the necessary information. They adhered to the rule with their best efforts or in good faith, mostly relying on the draught RTS.
With the publication of the final RTS, fund managers now have concrete advice they can apply to guarantee that their companies are in compliance with SFDR.
What fund managers should know about the finalised technical standards
Barring challenges from the European Council or the European Parliament, the RTS is now definitive.
The final standards offer templates for the Article 8 and 9 product-level disclosures required by SFDR as well as the entity-level PAI statement, which describes any possible environmental harm that could result from an entity’s investment choices.
The proposed standards fund managers utilised throughout the previous year are mirrored in the final RTS. The damage indicators that correspond to the PAI statement haven’t altered much, but the commission will still insist that funds follow its compulsory disclosure template when reporting harm indicators. Additionally, using the necessary templates, Funds must make periodic and pre-contractual disclosures under Articles 8 and 9.
However, there are still some unanswered financial issues even with the finalised RTS. It may be preferable for businesses to err on the side of caution and make sure their reports are as thorough as possible since, first, it is still unclear if fund managers can exclude any financial products from their PAI reports. Additionally, the commission has yet to offer a uniform definition or set of requirements for Article 8 and 9 products.
However, there are still some unanswered financial issues even with the finalised RTS. It may be preferable for businesses to err on the side of caution and make sure their reports are as thorough as possible since, first, it is still unclear if fund managers can exclude any financial products from their PAI reports. Additionally, the commission has yet to offer a uniform definition or set of requirements for Article 8 and 9 products.
Fund managers should start preparing now for the RTS’s implementation date of January 2023 notwithstanding these unanswered issues.
The following steps for fund managers
Fund managers should start becoming familiar with the required disclosure forms, such as the PAI statement, and the data they need. They should then start making plans to gather the necessary information and put in place the necessary processes to ensure compliance.
In order to meet the initial June 2023 PAI reporting obligations, enterprises should start collecting data from their present operating period because the PAI disclosure requires retrospective reporting from the 2022 calendar year.
Even though the SFDR primarily focuses on alternative investment fund managers (AIFMs) and other entities in the EU, certain regulations will have a significant impact on managers who are based outside the EU and who offer portfolio management, risk management, or non-discretionary investment advice to alternative investment funds (AIFs) in the EU. For instance, the portfolio manager will be expected to assist the EU-based AIFM in complying with the SFDR if the EU-based AIFM has delegated the portfolio or risk management role to a non-EU portfolio manager, which is a typical arrangement in some countries, such as Luxembourg. While non-EU portfolio managers may not be contractually compelled to follow the SFDR by the delegating AIFM in the EU, they may be under direct regulatory responsibility to do so.
While the SFDR and RTS may add new complexity for fund managers, they also give businesses a chance to show how their investment decisions are in line with ESG principles. This increases transparency and assurance for investors wishing to invest in ESG-focused or aligned funds. The disclosure process will be streamlined and organisations will be able to avoid the financial, regulatory, and reputational penalties associated with non-compliance by laying the framework now to acquire the pertinent data.
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