ESG Disclosure, SFDR. The start of things to come?

The new Sustainable Finance Disclosure Regulation (SFDR)[1] brings in its first wave of disclosure obligations from 10 March 2021 with the aim to provide more transparency on sustainability within the financial markets in a standardised way.

While normally one doesn’t get too excited about reporting, for the ESG (Environmental, Social & Governance) space it’s a big deal. As we wrote about recently the focus on this space by regulators is on the up, noting many consultations, requirements and asks are in the pipeline to ensure the goals set by COP (Conference of the Parties (COP26)) are achieved. 

So who’s in scope?

EU “financial market participants”, which include:

  • Fund managers (including AIFMs (Alternative Investment Fund Manager)) with respect to the funds they manage
  • Portfolio managers with respect to the portfolios they manage
  • Institutions for occupational retirement provision (IORPs)
  • EU financial advisors regulated by MiFID (Markets in Financial Instruments Directive) (with respect to their investment advice)

So what from today?

From March 10th, we see firm level disclosure where all firms must publish on their website a statement confirming whether they consider ”principal adverse impacts on sustainability factors” and their due diligence policies with respect to those impacts, or clear reasons why adverse impacts are not considered (“comply or explain”)

Where a firm considers the disclosure path, it must disclose:

Its policy on identifying and prioritising those impacts on “indicators” relating to climate, environmental, social and employee matters, respect for human rights, anti-corruption and anti-bribery matters

A description of the impacts and any actions taken or planned in relation to them

Its adherence to responsible business codes and, where relevant, its alignment with the objectives of the Paris Agreement

From 30 June 2021, “comply or explain” is no longer available for firms (and parent financial market participants of large groups) with over 500 employees.

Let's talk metrics

The SFDR really starts to bite when detailed reporting begins in the EU Taxonomy Regulation. This won't be easy.

Taxonomy Regulation applicable January 2022 (in respect of the two climate change objectives) and January 2023 (for other environmental objectives)

All "financial market participants" must disclose information on how their underlying investments meet the criteria for environmental sustainability, or state that they do not take account of the Taxonomy Regulation

Taxonomy Regulation must be used by funds that are promotes as environmentally sustainable (overlapping with Disclosure Regulation)

Metrics are specified in the 02/02/2021 technical standards and are to be phased in. Worth noting these don't apply until 01/01/2022 with the below regulatory technical standards (RTS) extract stating:

'While the requirements in the SFDR relating to the entity-level disclosure of principal adverse impacts apply from 10 March 2021, the additional detail specified by the entity-level 2principal adverse sustainability impacts statement' set out in the RTS is to be phased in. In particular, the RTS establishes a framework of reporting on principal adverse impacts by 30 June each year with a reference period of the previous calendar year. As the ESAs consider the RTS should apply from 1 January 2022, this means that the additional detail specified in the RTS must be reported in accordance with the RTS from that date. However, where a finacial market participant publishes the principal adverse sustainability impacts statement in accordance with the RTS for the first time, the RTS does not require the disclosure of information relating to a previous reference period. This means that the earliest information relating to a reference period to be disclosed in accordance with the RTS would not be made until 2023 in respect of a reference period relating to 2022'

So while 10 March 2021 was a key milestone that started the ball rolling, the bite will only really come once metrics off the back of EU Taxonomy start in 2022. How capable will local regulators be of monitoring the accuracy of reporting and fund managers be of producing the reports is what we'll be all be looking out for.

Still, we've got to start somewhere.

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