New regulations to clarify sustainability – an update on the SFDR

What is the SFDR and what does it affect?

The EU's Sustainable Finance Disclosure Regulation (SFDR) aims to prevent greenwashing, improve the transparency of investment products by increasing sustainability information, and promote the green transition by channeling cash flows towards more sustainable investments. It includes three legislations: the Taxonomy Regulation, the Sustainability Reporting Directive (CSRD), and the Sustainable Finance Disclosure Regulation (SFDR), which aims to provide transparent and therefore comparable information on the sustainability risks and impacts of companies' activities.

The SFDR requires financial actors to provide information on sustainability issues at both the product and company level. From March 2021, the minimum requirement for financial actors is to publish on their websites the principles on how they consider sustainability risks and information on how they consider negative sustainability impacts arising from investment decisions. The minimum requirements also include an obligation to disclose the level at which sustainability risks are taken into account in financial products and then to classify their products as complying with either Article 6, 8, or 9 of the Regulation.

Additions to reporting standards and investment advice guidelines

In January 2023, the SFDR was complemented by Regulatory Technical Standards (RTS) to harmonize the format and content of the information provided. The aim is to improve the comparability of products and operators, including for financial products, and the reporting of negative sustainability impacts through the use of templates attached to the technical standards.

In addition, from August 2022, service providers have been required to ask clients about their sustainability preferences when providing investment advice. The sustainability preference screening will give the client more control over the selected investments, including taxonomy investments, sustainable investments, or investments that take into account negative sustainability impacts.

Expanded reporting requirements put an end to greenwashing

The SFDR's reporting requirements have been expanded to prevent greenwashing. Under the reform, sustainable financial products have been divided into three different categories based on the extent to which they invest sustainably.

From now on, investment products can only be marketed as sustainable if they are SFDR-compliant and have specific sustainability features. SFDR-compliant sustainable products are classified as dark green (Article 9 of the SFDR), medium green, or light green (Article 8 of the SFDR):

• Article 8 products can be classified as light green (8) or medium green (8+) depending on whether they commit to sustainable investments without causing significant harm to any of the objectives in the definition, and whether the investee companies follow good governance practices in addition to promoting either environmental or social attributes as part of their investment activities.
• Article 9 products, the dark green products, make only sustainable investments and have a sustainability objective. These products are also subject to more extensive and detailed disclosure requirements. Information must be provided on which environmental and/or social attributes the product promotes or what its sustainable investment objective is. Information must also be provided on, for example, the product's sustainability targets, sustainability measurements, and strategy. Achievement of these targets must also be reported annually.

SFDR also requires taxonomy eligibility

The EU Taxonomy Regulation complements the SFDR Regulation by defining and setting the criteria for what is considered an environmentally sustainable activity. For Article 8 or Article 9 products, it is necessary to declare whether the product takes into account the classification criteria of the taxonomy.

The EU taxonomy contains six environmental objectives, and the criteria for achieving the first two, climate change mitigation and adaptation, have been in force since January 2022. The Commission is still preparing regulations for the other four environmental objectives: the sustainable use and protection of water and marine resources, the transition to a circular economy, pollution prevention and control, and the protection and restoration of biodiversity and ecosystems.

Product-specific reporting is particularly challenging, partly because the EU taxonomy is still incomplete and partly because the data on the taxonomy eligibility or alignment of target companies is not yet available. The path to the most comprehensive and comparable sustainability reporting possible can be facilitated by obtaining better data and reporting from investee companies.

New obligations also affect smaller companies

In addition to reporting obligations, companies face increasing expectations from investors, customers, and other stakeholders for more comprehensive and transparent sustainability data. With the pressure on data quality and availability, sustainability reporting requirements are trickling down through the supply chain of large companies. Increased expectations will therefore also affect the quality and availability of sustainability data from smaller companies, as they are often part of the supply chain of a larger company that is subject to the new SFDR reporting requirements.

At Greenstep, we help both financial institutions and their investee companies meet the EU's growing demands for better and more comprehensive ESG reporting. Get in touch with us!