Financial services providers can no longer communicate at will about sustainability now certain provisions of the Sustainable Finance Disclosure Regulation (SFDR)[1] have become applicable as of 10 March 2021. The SFDR imposes harmonized disclosure obligations on financial services providers to ensure that the sustainability features of their financial products can be better compared by investors. Up until now, sustainability disclosures have often been limited to vague, unsubstantiated and sometimes misleading marketing rhetoric.[2] This blogpost will discuss the transparency obligations of the SFDR that become applicable on 10 March 2021.
Transparency obligations for financial market participants and financial advisors
The SFDR divides financial services providers into ‘financial market participants’ and ‘financial advisors’. Financial market participants are manufacturers or providers of a wide variety of financial products like collective investment funds, investment based insurance products, a range of pension products and even individual portfolio management, which is qualified as a ‘financial product’ in the SFDR.[3] Financial advisors are investment firms, credit institutions, insurance intermediaries and undertakings that provide investment or insurance advice.[4]
The SFDR clarifies that environmental or social challenges, or bad governance practices, could cause an actual or a potential material negative impact to the value of investments. These ‘sustainability risks’ must be integrated in the investment, advisory and renumeration policies and must appear on the website of financial market participants and advisors.[5] When these risks are deemed relevant for a financial product, the precontractual disclosures must describe the integration of these risks in the investment decisions and include an assessment of their impact on the returns of the financial product.[6]
The SFDR furthermore acknowledges that investment decisions can have an adverse impact on sustainability factors. Financial market participants and advisors must make a statement on their websites describing whether and how they consider these adverse impacts of investment decisions, or provide reasons why they do not.[7] As of 30 June 2021, this comply-or-explain mechanism will be converted into an obligation to take such adverse impacts into account for large (groups of) companies with an average of at least 500 employees.[8]
Additional information obligations with regards to sustainable products
An important achievement of the SFDR is that it legally defines a ‘sustainable financial product’. Whereas the abovementioned obligations apply to all financial products, additional disclosure requirements apply to financial products which financial market participants classify as sustainable. Two categories of “sustainable” financial products cover the wide variety of products with various degrees of ambition regarding sustainability.[9]
The first category consists of financial products that ‘have sustainable investment as their objective’. A sustainable investment is defined as ‘an investment in an economic activity that contributes to an environmental […] or social objective provided that such investments do not significantly harm any of those objectives and that the investee companies follow good governance practices […]”.[10]
The second category consists of financial products that ‘promote, among other characteristics, environmental or social characteristics, provided that the companies in which the investments are made follow good governance practices’.[11] This catch-all category covers financial products that do not exclusively have sustainable investment as their objective. Although there is no definition of the ‘promotion of characteristics’ in the SFDR, the European Supervisory Authorities refer to best-in-class strategies, specific sectoral exclusions or even taking principal adverse impacts of investment decisions into account as examples. These characteristics must be translated into criteria for the selection of underlying assets that are binding on the investment decision-making process, meaning financial market participants may not disapply or override them at their discretion.[12]
If a financial product is classified in one of the two categories, financial market participants must describe the objective or the characteristics in precontractual disclosures and on the website, and explain how the objective or characteristics are measured, possibly using an index as benchmark.[13]
According to the SFDR, the content, methodologies and presentation of the ‘principle adverse impact statement’ and additional transparency obligations for sustainable financial products are to be further developed by a delegated act of the European Commission based on the advice of the European Supervisory Authorities (ESAs).[14] Due to a delay caused by the COVID-19 pandemic, the ESAs delivered their advice only on 4 February 2021 instead of 30 December 2020, and proposed to postpone the application of the future delegated act until 1 January 2022.[15] The Commission maintained the entry into force of the abovementioned obligations on 10 March 2021, but reckons that the application of the SFDR will be temporarily ‘high level and principle based’. This interim period of ‘high level and principle based’ application of the SFDR will be in place until the more detailed standards of the delegated act are adopted and become applicable. The ESAs added that they encourage national supervisors to already refer financial market participants and advisors to the templates set out in their advice to the Commission.
While the SFDR explicitly aims to create uniformity in sustainability disclosures, it makes its debut with a ‘high level and principle based’ approach that may lead to fragmentation in the way sustainability information is communicated to investors. Despite the peculiar transition period, the applicability of the SFDR marks an important milestone in the transformation of the financial sector towards improved non-financial risk management and more credibility for investors seeking to invest sustainably.
Arnaud Van Caenegem is a PhD Researcher at the KU Leuven, where he is currently preparing a PhD on the legal framework governing sustainable collective investment funds at the Jan Ronse Institute for Company and Financial Law.
[1] Regulation Council and Parliament nr. 2019/2088, 27 November 2019 on sustainability‐related disclosures in the financial services sector, Pb.L. 9 December 2019, L 371, 1 (hereafter: SFDR) amended by Regulation Council and Parliament nr. 2020/852, 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088, Pb.L. 22 June 2020, L 198, 13 (hereafter: Taxonomy Regulation) which I discussed in a previous blog post.
[2] See B.J. RICHARDSON, Fiduciary law and responsible investing: in nature’s trust, New York, Oxfordshire, 2013, 216; An empirical study conducted in the US comes to the same conclusion: D. BRAKMAN REISER and A. TUCKER, “Buyer beware: variation and opacity in ESG and ESG index funds”, Cardozo Law Review 2020, (1921) 1975-1976.
[3] Article 2(1) SFDR.
[4] Article 2(11) SFDR.
[5] Articles 2(22), 3 and 5 SFDR.
[6] Article 6 SFDR.
[7] Article 4 SFDR.
[8] Article 4(3)-(4) SFDR.
[9] EUROPEAN SUPERVISORY AUTHORITIES, “Final Report on draft Regulatory Technical Standards”, Nr. JC 2021 03, 2 February 2021, 15 (Hereafter: ESAs Final Report).
[10] Articles 2(17) and 9 SFDR.
[11] Article 8 SFDR.
[12] ESAs Final Report, 15.
[13] Articles 8, 9 and 10 SFDR.
[14] Articles 2a(3), 4(6)-(7), 8(3), 9(5) and 10(2) SFDR.
[15] ESAs Final Report, 7.
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