The European Union (EU) has set in motion an ambitious legislative programme to make environmental, social and governance (ESG) concerns a central plank of regulation in the financial services industry.
As part of this package, the Regulation on sustainability-related disclosures in the financial services sector (the SFDR) was published in December 2019.
EU Sustainable Finance Disclosure Regulation
The EU Sustainable Finance Disclosure Regulation (SFDR) is a new set of European Union rules that came into effect on March 10, 2021, with the goal of making the sustainability profile of funds more comparable and easy to understand for investors. They categorise products into specific types and include metrics for assessing the environmental, social and governance (ESG) impacts of the investment process for each fund.
As the name suggests, this regulation will place much more emphasis on disclosure. The information on this page describes the approach to SFDR in accordance with these new rules. However, firms may have different approaches based on their understanding of the rules.
Background to SFDR
SFDR is part of the EU’s wider Sustainable Finance Framework, which is backed by a broad set of new and enhanced regulations that will apply across the region. The framework includes the Sustainable Finance Action Plan, which aims to promote sustainable investment across the EU, and a new Taxonomy to categorise economic activity through a sustainability lens and help create a level playing field across the region.
Many of the new measures are a response to the landmark Paris Agreement on climate change in December 2015, and the United Nations 2030 Agenda for Sustainable Development published earlier the same year, which set out the 17 Sustainable Development Goals. SFDR and other regulations are also aligned with the European Green Deal, which aims for the EU to be ‘climate neutral’ by 2050.
Product classifications under SFDR
The most visible and impactful aspect of SFDR is the classification of funds and mandates into three categories, as laid out by Articles 8 and 9 of the SFDR and those funds not defined by either article, referred to as ‘neutral’ funds.
Neutral funds do not integrate any kind of binding sustainability controls into their investment process and can include stocks that may be excluded by ESG-focused funds, such as tobacco companies or thermal coal producers. While neutral funds are still allowed to be sold in the EU – provided they are clearly labelled as non-sustainable – they may not be promoted as ESG funds when matched against more sustainable products.
Among other characteristics, Article 8 products promote environmental or social characteristics, or a combination of those characteristics, provided the companies in which investments are made follow good governance practices.
Article 9, also referred to as ‘products targeting sustainable investments’, covers products targeting bespoke sustainable investments and those that have sustainable investment as their objective.
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