What is SFDR?
Introduced in 2019, Sustainable Finance Disclosure Regulation (SFDR) is an EU regulation with the objective of enhancing transparency in the financial market for sustainable investment. This regulation has been a fundamental pillar of the EU Sustainable Finance agenda and came into effect in March 2021. SFDR focuses on preventing “greenwashing” and requires financial firms to disclose sustainability-related information in a comprehensive manner.
As a key segment of the European Commission’s 2018 Sustainable Finance Action Plan, SFDR has been a fundamental pillar of the EU Sustainable Finance agenda. This regulatory framework is an essential part of the EU Green Deal that aims to transform the EU economy and make it climate-neutral by 2050.
SFDR: Objectives and Scope
The SFDR provides a roadmap to all financial market participants (FMPs) and financial advisers in the EU that consist of investment firms such as asset managers, insurance companies, pension providers, banks, venture capital funds, and credit institutions offering portfolio management or financial advice. FMPs with more than 500 employees are required to report on a set of Principal Adverse Impact (PAI) indicators and how they incorporate them in their investment decision process.
The reporting framework sets rules for FMPs to disclose their sustainability risks and encourages them to shift capital towards sustainable activities. By increasing transparency around sustainability claims made by entities, SFDR assists in better decision-making for investors.
The major goals of the SFDR framework are…
- To encourage sustainable activities in the financial sector by reorienting capital towards sustainable activities
- To prevent greenwashing through reliable and relevant standards
- To enhance transparency for EU investors for easy comparison of the firm’s sustainability claims
- To create a level playing field across the bloc for measuring and disclosing sustainability factors
Reporting entities have been complying with Level 1 disclosure requirements wherein information has to be provided on a ‘comply or explain’ basis regarding identification, description of the PAIs, as well as the relevant action plan. The detailed Level 2 disclosures will apply to FMPs from January 2023, which will require them to disclose their ESG (Environmental, Social, Governance) considerations in addition to the PAI reporting. Level 2 disclosures will introduce regulatory technical standards (RTSs) and Taxonomy-related disclosures. The first reports from the scoped entities are expected by July 2023.
Impact of SFDR on ESG reporting
Companies today are now focussing on becoming socially conscious and embracing environmental sustainability as their central goal. With investors pressing for useful and reliable sustainability disclosures, global regulatory bodies are coming up with reinforced regulations in order to shift resources toward a more sustainable economy. In order to establish a common sustainability framework, the European Commission is striving to bring in major changes toward standardizing ESG terminology, reporting, and disclosures. With the introduction of the SFDR regulation, the EU seeks to enforce and align ESG-related disclosures to help investors make investment choices that are in line with their sustainability goals.