What is the SFDR regulation?

In business, it’s often difficult to distinguish true sustainable practices from greenwashing. The same is true with investing. Fortunately, responsible investors can now rely on the Sustainable Finance Disclosure Regulation (SFDR) to help them cut through the noise. The new regulation sets a European standard of environmental, social and corporate governance (ESG) disclosures for all financial market participants (FMPs) such as investment firms, pension funds, asset managers, insurance companies, banks, and for financial advisors.

It was introduced by the European Commission and came into force on March 10, 2021.

SFDR, a regulation to harmonize ESG disclosures

The SFDR aims to make the sustainability profiles of funds more comparable and easier to understand by investors. The regulation defines three categories of funds, from least to most sustainable:

• “Article 6” funds do not include any kind of sustainability
• “Article 8” funds promote environmental and/or social characteristics (must also have good governance practices)
• “Article 9” funds have sustainable investment as their objective

As part of the disclosure requirements, the EU has set out a number of indicators to assess the sustainability of funds. Those are called “Principal Adverse Impact Indicators”. They find their roots in the usual ESG metrics investors look out for such as: carbon emission, fossil fuel exposure, gender diversity, exposure to corruption…

All FMPs, including ETF providers, will have to disclose those on their websites, prospectuses, reports and Key Investor Information Documents (KIIDs) for each of their funds under the new European regulation.

Timeline of SFDR implementation

The SFDR regulation will be implemented in multiple steps.

It first came into force on March 10, 2021, but large FMPs (with 500+ employees) have been granted a delay. They have until end of June 2021 to disclose their policies with regards to investment decisions on the principal set of sustainability indicators.

In 2023, FMPs will need to publish a first statement on their sustainability metrics (the “Adverse Sustainability Impacts Statement”). Put simply, the statement is a summary of the FMP’s assessment and actions towards the sustainability indicators.

In 2024, FMPs will be subject to the same publication requirements as in 2023 and will need to issue a second sustainability statement.

Limits of SFDR regulation

While the SFDR is a great step forward in harmonizing the industry around ESG, it still has its limits.

A major limit of the exercise is self-assessment by FMPs of the sustainability of their offer. The classification of funds within Articles 6, 8 or 9 is not performed or validated by a third party. This means that in some situations, a fund’s SFDR classification may not match its true ESG-ness.

Also, investors should keep in mind that SFDR is still a recent regulation and it may evolve over time.

Official documents concerning this regulation can be found here.

Interested in ESG investing? Check out ESG Investing hub, a dedicated portal with all you need to know about ESG funds.