Sustainability has become one of the most important concepts in several industries worldwide, including the food and fashion industries, with consumers showing an increased demand for more sustainable products. The finance industry is no exception, as the deadline of implementation of Regulation (EU) 2019/2088 on Sustainable Finance Disclosure Regulation (“SFDR”) is fast approaching, with the aim to increase transparency, limit greenwashing and ensure comparability for investors. By 10 March 2021, entities impacted will need to ensure they have all the relevant disclosures and policies in place. This does not come without challenges, particularly due to the tight deadline, not to mention the fact that the finalised Regulatory Technical Standards (“RTS”) were only published by the European Supervisory Authorities (“ESAs”) last week and are yet to be endorsed by the European Commission (“EC”).
Who is impacted by SFDR?
As part of a wider global effort for sustainable development, SFDR aims to establish harmonised rules for Financial Market Participants (“FMPs”) and Financial Advisers (“FAs”) to incorporate sustainability risks and consider the adverse impacts on sustainability embedded within their processes. It also details the provision of sustainability related information for Financial Products (“FPs”). Article 2 of SFDR delves deeper into the definitions of each of the three impacted entity groups. FMPs refer to entities such as Alternative Investment Fund Managers (“AIFMs”), undertaking for collective investment in transferable securities (“UCITS”) management companies and investment firms providing portfolio management. Alternatively, FAs refer to entities providing advice such as AIFMs, UCITS management companies or investment firms providing investment advice. As outlined above, SFDR is also applicable to FPs, which include Alternative Investment Funds (“AIFs”), UCITS funds and managed portfolios/accounts.
What are the main requirements of SFDR?
SFDR requirements can be split into two: requirements at entity level; and requirements at product level.
At entity level, FMPs and FAs will be required to disclose on their website information on their policies in relation to the integration of sustainability risk when it comes to investment decisions or advice. FMPs and FAs will also be required to update their remuneration policies to ensure they are consistent with the integration of sustainability risks. This information should also be disclosed on their websites. Furthermore, FMPs and FAs will have to disclose on their website, taking a “comply or explain” approach, whether they consider principle adverse sustainability impacts when making investment decisions or giving investment advice. The RTS contain more detailed information on what is to be presented in this respect and outlines the different requirements for FMPs and FAs. For FMPs with more than 500 employees or which are a parent undertaking of a large group with more than 500 employees the “comply or explain” approach in relation to the principle adverse sustainability impacts will become mandatory as at 30 June 2021.
At product level, FPs will need to be categorised into three groups: those that have no focus on sustainability; those that promote environmental or social characteristics; and those that have sustainability as their objective. For all three categories of FPs, FMPs and FAs will need take a “comply or explain” approach in their pre-contractual disclosures, such as the prospectus. If sustainability risk is deemed to be relevant, the disclosure must outline how sustainability risks are integrated into the investment decision or advice and the results of the assessment of the likely impacts of sustainability risk on their return. Otherwise, should sustainability risk be deemed as not relevant, the disclosure must give a thorough explanation for this. By 30 December 2022, FMPs will also have to take a “comply or explain” approach for all three categories of FPs when it comes to the consideration of the product’s principal adverse sustainability impacts. When it is determined that FPs promote environmental or social characteristics, pre-contractual disclosures are to be made outlining how such characteristics are met and, should an index be designated as a reference benchmark, how the index is consistent with these characteristics. Should an FP be categorised as having sustainable investment as its objective, the FMP should determine whether an index will be used as a reference benchmark. Should an index be used, a pre-contractual disclosure is required and must outline the information as to how the designated index is aligned with that objective and how this differs from the broad market index. If an index is not used, the pre-contractual disclosure should outline how the sustainable investment objective is attained. FPs with environmental or social characteristics or a sustainable investment objective must also disclose certain information on their website and, as from 1 January 2022, must also include disclosures in their periodic reports.
What are the main challenges of SFDR?
SFDR brings with it a few challenges for the financial industry. The looming deadline is one of these challenges, especially when considering that the finalised RTS which help provide further clarity on how certain disclosures are to be made were only published last week. Furthermore, categorising FPs into different groups is quite challenging and time consuming, especially when taking into consideration that certain environmental and social information may not be as accessible as desired. This may pose the risk of higher costs. FMPs and FAs who opt for the “explain” route may also be negatively impacted, as the demand for sustainability increases by investors.
On 9 February 2021, the MFSA published a circular outlining the process it will be adopting with respect to the submission of updates made to the pre-contractual documents of locally based Collective Investment Schemes. The MFSA has established a fast-track filing process whereby UCITS management companies, AIFMs and investment firms will be able to “self-certify” their compliance with SFDR and notify the MFSA accordingly. The circular also outlines a list of documentation to be submitted along with a note that submissions made after 3 March 2021 will be processed on a best-effort basis by the MFSA before 10 March 2021.
Glorianne Gatt, Senior Compliance Associate, RMC Wise Limited