SFDR Level 2 reporting is coming to its inaugural wrap soon. To no one’s surprise, SFDR reporting isn’t all that easy.
I’m Toby, and I’ve been working at Briink for 2 years now. I spend a lot of time working on SFDR reporting for clients, and learning about SFDR reporting strategies that exist in the market. Through this article, written via a series of conversations with funds that have completed their first SFDR reporting independently, I want to outline what lessons have been learned from doing it the hard way.
SPOILER ALERT: A lot of funds I've spoken to have expressed that a lot of uncertainty remains in terms of how to actually get SFDR reporting done. Many rules are unclear, and best practices don't yet exist: in other words, there isn’t yet a one-size-fits-all way to conduct your SFDR reporting (by the way, if this sounds completely new to you, feel free to check out our new white paper on SFDR reporting).
Here at Briink, we can reduce the time it takes by up to 10x. But that still requires time and investment: We’re working with clients to build the customizable AI-driven solutions that take your SFDR reporting from good to great. If you’re interested in learning how we can help build those for you, you can find me here.
Lesson #1: The early bird catches the… data gaps?
Whether early-stage VC or large cap private equities, all funds I have spoken with have encountered significant data gap challenges in their SFDR reporting. Most prominently, for PAI reporting’s GHG emission measurements, and across Taxonomy assessments.
While it is as of yet unclear where leniency exists in the SFDR (for example, can early-stage VCs whose portfolio companies can’t measure emissions to water simply answer ‘unable to provide’?), most funds I’ve spoken with prefer to take a conservative approach to proxy data (and rightly so). When stakes aren’t yet clear, there is serious risk attached to the unknown: Those funds that started to tackle these requirements earlier (namely, in the first months of 2023) were able to fill them with more confidence, and at a lower cost due to the longer available timeline.
Dot your i’s, cross your t’s, and get your SFDR reporting done ahead with (relative) ease.
Lesson #2: You can’t manage what you haven’t read twice
The EU Commission had many intentions when bringing the SFDR and Taxonomy into force. Ease of understanding didn’t rank all too high on that list.
The funds I have spoken with that were able to deeply understand the regulation before engaging in reporting suffered fewer dead-ends, miscommunications, and compliance risks. And, if doing so without support (like our machine-learning driven simplifications!) - that takes time and effort. Investing in understanding the regulatory details, inevitably, saves costs in the medium term.
Lesson #3: Data management and review is crucial - and really, really hard given its unstructured nature
Similar to data gaps in reporting, it is (as of yet) unclear to funds what compliance risks are associated with the auditing of non-compliant data. A conservative approach seems to be the standard here, too.
Getting a robust verification and data management process in place for portfolio company evidence isn’t easy manually, given the challenges associated with managing large stores of unstructured data. Two of the funds I spoke with referenced having to look through multi-hundred page documents to find single paragraphs relevant for Taxonomy reporting.
Putting together a streamlined, defensible process for the management of sustainability data and verification thereof is only going to become more important as reporting requirements continue to expand exponentially. It’s important to find one that conforms to your needs and strategy specifically.
We are building some really cool malleable NLP models that can help you search through and identify evidence in large sums of unstructured data. If that piques your interest, I’d like to speak with you and learn more about which problems you’d like them to solve.
Lesson #4: Point fingers, early
A key point from all funds was the importance of nominating a colleague to own the reporting process in its (intimidating) entirety.
Having one central point of contact for all matters of SFDR is critical for building and managing a process. In the coming 6 months, this colleague should be tasked with improving these processes and ensuring the time and resource cost of next year’s reporting is lower than this year’s splurge to be confident it gets done on time.
You can ease your colleague’s SFDR symptoms by requesting extra support and guidance from a consulting firm, but treating the root cause involves making sure to invest in turning SFDR reporting into a scalable and replicable exercise. One that doesn’t require repeated, expensive advisory every year. As this regulation will become a more central part of (and a necessary condition for) your ESG efforts, relying too much on non-scalable external solutions is putting a very expensive bandaid on the real problem.
This point transitions to the final key learning:
Lesson #5: The process is a process
No one I spoke to was expecting this year’s reporting to go seamlessly. And it didn’t.
It won’t go perfectly next year either, and it won’t suddenly become easier to report 100% (or perhaps any!) Taxonomy alignment as a fund. Creating productive, iterative processes will help funds view their reporting as a continuous journey, filled with aspirations and potential for competitive advantage. While there is a fear of ‘all or none’ sustainability among GPs, LPs are beginning to voice enthusiasm for year-on-year improvements and transitional investors.
This is also part of the reason why off-the-shelf reporting platforms are often not the best fit for organizations that want to explore different approaches. It will take time and an experimental mindset to understand what resonates the most with purpose-driven LPs, and focusing on checking boxes will not necessarily be the way to stand out in a crowded market.
Of course, there is another side: When the SFDR was still a relatively new regulation, many fund managers thought they could get away without the help of any external tool or provider whatsoever. Which will almost certainly not be the best strategy in the long term, as requirements start ramping up.
My two cents? Finding the right balance between building flexible-enough processes to navigate this uncertain and ever-evolving space and investing in scalable and more cost-effective solutions won’t be easy, but it will certainly make a difference between a great ESG strategy and an “ok” one.
Those were the big lessons a year of getting ready for the first big wave of SFDR disclosures taught me - and I have the feeling that we’re still just scratching the surface.
I guess that the key meta-learning for me is: despite the growing demand for sustainable finance solutions, the current market falls short in meeting the diverse requirements of various industry participants. Consultancy services offer personalized guidance but lack scalability and automation. Off-the-shelf software solutions, on the other hand, provide standardized frameworks but often fail to adapt to the specific needs of individual organizations.
I personally believe that the choice between consulting services and off-the-shelf software is really a false dichotomy.
We’re here to fix that.
Leveraging Large Language Model (LLM) technology, and sustainable finance expertise, we are pioneering a new approach to building customizable ESG infrastructure that seamlessly integrates with our customers' ESG workflows.
If you’d like to learn how we’re continuously building these learnings into our product, write me at email@example.com or book a short chat here.