The Sustainable Finance Disclosure Regulation (SFDR)
Greenstone
Award-winning sustainability, supply chain and investor ESG Software-as-a-Service solutions used in over 100 countries.
The Sustainable Finance Disclosure Regulation (SFDR) has made a significant impact in the sustainable finance sphere since its introduction in 2021. This regulation, which officially came into effect on March 10, 2021, requires all financial market participants in the European Union (EU) to report Environment, Social and Governance (ESG) disclosures, with additional requirements for products that promote ESG characteristics or that have sustainable investment objectives.
There is a lot of discussion about what SFDR means for financial firms and ESG reporting. Our team of industry experts has written the following article, addressing the key points and meaningful deadlines of the regulation that businesses should be aware of.
What is SFDR?
SFDR is part of an extensive ESG-based set of regulations implemented by the EU. The principal aim of this legislation is to redirect capital flow towards sustainable finance. Another key objective of SFDR is to prevent ‘greenwashing’ and provide transparency on sustainability within the financial market to ensure that financial market participants (FMPs) are able to embed sustainability into decision-making.
Transparency is a vital aspect of this legislation, as it focuses on how providers of financial products manage and reduce sustainability risks. There are specifications at both entity and product levels. Specifically, the SFDR establishes and implements transparency criteria for financial commodity characteristics, allowing them to be compared based on their sustainability level.
Who does SFDR apply to?
The SFDR regulation applies to FMPs such as investment firms, pension funds, asset managers, insurance companies, banks, venture capital funds, credit institutions offering portfolio management, or financial advisors. FMPs with fewer than 500 employees are not captured under the SFDR (although under the ‘comply-or-explain’ principle they are obligated to explain why).
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What information needs to be disclosed under SFDR?
FMPs in the EU are required to disclose information on both their sustainability practices (entity-level) and their financial products (product-level). If these FMPs’ financial products make sustainable investments, the manager is required to demonstrate how those investments abide by the regulation's "do no significant harm" policy.
FMPs need to also report on their Principal Adverse Impacts (PAIs) at both an entity- and a product-level. There are 50 PAI sustainability indicators (some mandatory and some voluntary) covering a range of ESG issues including greenhouse gas emissions, human rights and waste management. The regulation guidance regarding the timing of the reporting requirements on these PAIs is complex, but the entity-level reporting framework for PAIs began as a "comply or explain" requirement, shifting to "comply" for large FMPs on June 30, 2021.
Best practices on how to adapt to the regulation
When approaching the SFDR regulation, one of the initial steps is establishing which sections are?relevant to your company and products. Then we suggest the following steps:
Key dates for SFDR
Dec 31 2023:?End of 3rd?reference period
June 30 2024:?The FMP must complete disclosure with a historical (year-on-year) comparison.