SFDR overview

We help you understand the challenges of sustainable investment and ESG regulations, including the Sustainable Finance Disclosure Regulation (“SFDR”) that came into force on 10 March 2021 in the EU.

Although SFDR does not apply in the UK, SFDR does apply to EU and non-EU AIFMS, UCITS management companies and MiFID firms providing the service of portfolio management marketing funds into the EU under national private placement regimes.

SFDR key concepts

The SFDR introduces a number of new concepts that firms will need to understand when disclosing their ESG approach.

Reminder of the high-level impacts:

SFDR is part of an action plan and it applies at both firm and product level in respect to all financial products. SFDR requires all AIFMs, UCITS management companies, and MiFID firms providing the service of portfolio management to make certain pre-contractual, website and periodic disclosures on various sustainable investment issues. At a high level, these include:

For all relevant entities

How the entity integrates sustainability risks into the investment decision making process, how the entity takes account of the principal adverse impacts of investment decisions on sustainability factors (on a comply or explain basis) and how their remuneration policies are consistent with the integration of sustainability risks. Firm level obligations include:

For all relevant products

Remember that all of your products are captured – not only those with an ESG focus. All products will need to disclose the likely impacts of sustainability risks on the returns of the product (or explain why such risks are not considered relevant). If the relevant entity is complying with the principal adverse impact requirements, each of that entity’s products will also need to disclose whether and how it considers the principal adverse impacts on sustainability factors. Product level obligations for all financial products include:

In addition, the disclosures requirement provided by Article 5, Article 6 or Article 7 of the Taxonomy Regulation have been applicable since 1 January 2022, with regards to the first two environmental objectives of the EU Taxonomy. Those disclosures must reflect whether and to what extent the investments underlying the financial product consider the EU criteria for environmentally sustainable activities. Detailed content and presentation of the Taxonomy-related disclosures are provided by the Level 2 requirements, applicable as of 1 January 2023.

For ESG focused products

Products that promote environmental or social factors (Article 8) or have a sustainability objective (Article 9) have additional disclosures to be made, following detailed frameworks set out in the Level 2 regulation. Product level obligations for ESG focused products include:

According to a recent survey conducted by the EFAMA,  Article 8 SFDR funds had net assets under management of EUR 3.7 trillion and Article 9 funds had net assets under management amounting to EIR 340 billion at the end of the first quarter of 2021.

 Be ready for the application of Level 2

1. Remember the UK!: Although SFDR will not be directly applicable, your UK operations may still be indirectly caught – for example in the following circumstances:

• if you will continue to market your funds into the EU as of 1 January 2021
• if, as we have seen with a number of fund managers, your firm is part of a group that has decided on a global basis to implement SFDR as a baseline commitment to effective ESG disclosure – meaning their entities and funds can be aligned with those in the EU. Many firms consider this to be a key commercial imperative, reflecting the needs of their investors.
• Remember TCDF!: In the UK, The Task Force on Climate Related Financial Disclosures has determined various obligations, including:

2. Don’t underestimate the preparation involved. Compliance with SFDR is a time intensive task, bespoke to every entity and product. Although framed as requiring only disclosures, it in practice requires firms to make strategic business and policy decisions – which will then need to be disclosed. It is not possible simply to include a standard disclosure in your prospectuses or PPMs or on your websites.

3. Be aware of the implications of the Level 2 delay. The SFDR disclosures outlined above are supplemented by Level 2 measures, which set out in much greater detail what firms need to disclose at both an entity and a product level. These include a number of highly detailed and scientific metrics, many of which would have been impossible to obtain and disclose by 10 March 2021. Following industry feedback, the European Commission adopted a Delegated Regulation on 6 April 2022, which confirms that compliance with these more onerous requirements will be until January 2023. ESG-focused must publish their sustainability-related pre-contractual disclosures in form of a mandatory annex for the Article 8 and Article 9 products. Greater detail than Level 1 SFDR is expected, including minimum proportion of sustainability-related investments which are binding commitments, explanations of the processes applied to collect the principal adverse impact indicators, calculation of Taxonomy-alignment in graph representation, etc. Although this is good news for now, it does not remove the issue entirely. The main requirements will still apply and so these will need to be dealt with on a best efforts, principles based approach. Practically this is a challenge as:

• you will have to consider how best to approach these disclosures on a more narrative, qualitative basis;
• it effectively means a two-stage compliance, with updates required again when Level 2 comes into force;
• the data for the PAI reporting must be collected from 1 January 2022, although the Level 2 is not yet approved by the European Commission and
• the data problem of how to source the required disclosures remains an issue for the industry as a whole.

How we can help

We are advising many of our fund managers across Europe on the implementation of SFDR and have an expert team across all fund types and asset classes. We can assist in many ways depending on your internal needs and resourcing, including:

• assisting with scoping out how your firm and products will be affected by SFDR, including analysis for determining whether a particular product will fall under Article 8 or Article 9;
• providing detailed frameworks for compliance with the various disclosures;
• assisting with the drafting of the relevant policies and disclosures;
• general support with the business in understanding the far-reaching effects of SFDR and identifying any gaps in our existing ESG materials.

Our experience and approach add real value to the fund managers whom we advise:

The constant evolution of the regulatory landscape is beneficial to the industry but also a main source of challenge, due to its uncertainty and different interpretations.

Whether you are launching, operating, lending to or investing in a fund or an alternative indirect investment vehicle, CMS Funds Group understands not only your business and your requirements, but also the funds landscape and its markets. To find out how we may help you, and to access materials to help with your day-to-day operations and investment decisions, visit our page.

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