With the launch of the EU Green Deal in December 2019, the EU has set a course to steer capital flows toward a more sustainable future. According to the Green Deal, the EU should become climate-neutral by 2050 – and thus make Europe the first greenhouse gas-neutral continent. To meet these ambitious goals, the EU has passed several regulations as part of the Green Deal and the Sustainable Finance Strategy. These are intended to increase transparency for investors in order to make sustainability criteria an important part of investment decisions. Alongside the EU Taxonomy Regulation and the Corporate Sustainability Reporting Directive (CSRD), the Sustainable Finance Disclosure Regulation (SFDR) is one of the most important EU regulations for corporate transparency.
What is the purpose of the SFDR?
The SFDR is intended to support the financing of sustainable growth while preventing greenwashing through greater transparency. The disclosure requirements of the SFDR are intended to illustrate to investors and the public the extent to which companies or products meet sustainability benchmarks. Therefore, there are requirements at both the company and product levels. The SFDR complements the EU Taxonomy and the CSRD to form an overarching EU "Sustainable Finance Framework". This framework aims to anchor sustainability principles at various levels of the economy. Learn more about the Sustainable Finance Framework in our Insight Article.
Which companies are affected by the SFDR and when?
The SFDR is targeted at financial companies in the EU with 500+ employees. This includes companies that develop and offer financial products, so-called financial market participants and financial advisors. This applies, for example, to banks, insurance companies, or asset management companies. Financial products within the scope include investment and mutual funds, private and occupational pension plans, insurance investment products, and insurance and investment advice.
The disclosure requirements will be phased in over the years 2021 to 2023, with most of the requirements of the SFDR already required to be reported since March 30, 2021. When SFDR Level 1 became effective in March 2021, the principles of the framework were introduced. As of January 1, 2023, the regulatory technical standards for SFDR Level 2 must now be applied. These contain further guidance on the content, methods, and presentation of information.
What do companies need to report?
The SFDR requires disclosures at the company level as well as at the product level.
Financial companies must report on how they incorporate sustainability aspects into investment decisions at both the company and product level. In addition, financial companies must disclose their Principal Adverse Impacts on Sustainability (PAIs). PAIs consist of core indicators and additional opt-in indicators from the areas of greenhouse gas emissions, energy efficiency, biodiversity, water, waste, social and employee affairs, human rights and corruption. The information on PAIs must be published by the affected companies on their website.
At the product level, the SFDR additionally distinguishes three categories of financial products, with disclosure requirements varying by product group:
General financial products
ESG financial products with the aim of sustainable investment (Article 9 - dark green)
ESG financial products with environmental or social characteristics (Article 8 - light green)
In all three categories, pre-contractual information on the product must be provided and reports on the development of the product must be published on the website. For general financial products, the PAIs and a statement on their inclusion must be reported. For ESG financial products (groups 2 and 3), additional disclosure requirements apply including specifications on their ESG characteristics. The difference between ESG financial products with environmental or social characteristics (Article 8) and ESG financial products with the aim of sustainable investment (Article 9) lies in the structure and marketing. While Article 8 financial products only feature individual environmental or social characteristics in the investment decision, Article 9 products pursue a targeted sustainability effect as a key objective (e.g. reduction of greenhouse gas emissions). In the reports, the ESG characteristics or the achievement of the sustainability impact objective should, if possible, be made quantifiable through KPIs or compared with benchmarks. In the case of a product with environmental sustainability features, a report in accordance with the EU Taxonomy must also be published from 2023.
What challenges does SFDR pose for companies?
Affected financial companies must familiarize themselves with the regulation and understand the requirements to be disclosed. One of the key challenges is certainly the time and effort required to collect the necessary data and evidence.
Companies must ask themselves how they can obtain the required ESG data in the first place. In this regard, financial firms rely primarily on their investment objects, i.e., the companies in which they invest, to truthfully collect and share information. The impact of the SFDR thus also extends to non-financial companies, as their investors will require relevant sustainability data. This means that in the long run, ESG data collection and disclosure will be important for companies in every sector in order to maintain their attractiveness to investors.
Moreover, financial companies also need to define sustainability indicators for internal and in-house projects and deal with their implementation. This requires additional capacity.
The SFDR thus obliges financial companies to collect and structure sustainability-related information. However, the SFDR also has implications beyond the financial sector. This is due in particular to the interconnectedness of the financial sector with the overall economy and its importance for investment and financing activities.