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Europe and ESG: Counting Down to SFDR

By Francesco Cavallini, Client Relationship Director, IQ-EQ.

In its commitment to channeling private financial flows towards investments that support Paris Agreement targets – and more broadly the United Nations’ Sustainable Development Goals (SDGs) – the European Union adopted the European Green Deal in March 2018. Some policy initiatives within this deal specifically target the finance industry, and more precisely the alternative investment sector. Among the most relevant (and indeed imminent) policies is the Sustainable Finance Disclosure Regulation, or SFDR.

SFDR relates to the publication of information from financial market participants on the sustainability of their investment decisions. Once the new regulation takes effect, such parties will be required to disclose at entity and product level how they build sustainability into the products they provide and how products that are branded as sustainable achieve their objectives.

Most of the requirements will apply from 10 March 2021.

Who is impacted by SFDR?

SFDR applies to all ‘financial market participants’ that are based or marketing within the EU. This includes alternative investment fund managers (AIFMs) – including non-EU managers in certain instances.

A brief overview of SFDR requirements

As of 10 March 2021, financial market participants must publish on their website:

  • Information about their policies regarding the integration of sustainability risks in investment decision-making processes
  • Information regarding adverse sustainability impacts on investment decisions, depending on whether or not these have been considered:
    • Where adverse impacts are considered, a statement on the related due diligence procedures must be published
    • Where adverse impacts are not considered, ‘clear reasons’ must be provided for why they are not, including, where relevant, information as to whether and when they intend to consider such impacts
  • Information on how their remuneration policy is consistent with the integration of sustainability risks.

As of 10 March 2021, financial market participants must include the following in their pre-contractual documents:

  • The manner in which sustainability risks are (or are not) integrated into investment decisions
  • Results of an assessment of the likely impacts (or lack thereof) of sustainability risks on the returns of the financial product made available.

Depending on each financial market participants’ policies on the integration of sustainability risks in their investment decision-making process, additional pre-contractual disclosures may apply:

  • Where financial market participants do not consider the adverse impacts of investment decisions on sustainability factors, by 10 March 2021 their pre-contractual documents must include a statement to that effect and the reasons therefor
  • Where financial market participants do consider the adverse impacts of investment decisions on sustainability factors, by 30 December 2022 their pre-contractual documents must include a ‘clear and reasoned explanation’ of how they are considered.

Regulatory Technical Standards are currently being finalised and are expected to be published in the coming months. These will include more details about the disclosure requirements. However, for now, financial market participants are required to comply with the above requirements on a best effort basis.

Additional disclosures (website, pre-contractual and periodic reports) will apply to ESG-focused alternative investment funds that promote environmental or social characteristics and/or have sustainable investing in their objectives.

What does this mean in practice?

Financial market participants, including alternative fund managers, will need to update their websites and pre-contractual documents by 10 March 2021 despite the current lack of Regulatory Technical Standards. Certain regulators have also requested submission of the updated pre-contractual documents.

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