Ahead of the Sustainable Finance Disclosure Regulation (SFDR) level 2 coming into force at the beginning of the new year, financial market participants (FMPs) need to consider how to adapt their processes to ensure compliance with the regulation. With SFDR targeting enhanced transparency and sustainability of financial products and services, there will be a lot of focus from stakeholders (including regulators) on how FMPs adapt to the new regime, so getting this right is key.
The SFDR is relevant for a wide range of FMPs, including financial institutions, asset managers, insurance companies, and pension funds. With SFDR level 2 coming into force, these entities will be required to disclose information on the sustainability risks and impacts of their products and services, as well as their ESG policies and outcomes. These policies will make sure that the markets have the right level of information they need to judge the sustainability of various financial products and make informed investment decisions.
The SFDR level 2 is the application of the Regulatory Technical Standards (RTS), first introduced by the ESAs on 6 April 2022.
These standards outline the specific disclosure requirements that FMPs must follow, including the types of information that must be disclosed and the format in which it must be presented.
Under the RTS, different types of FMPs have varying disclosure obligations. For example, asset managers have to disclose information on their websites with detailed information on the principal adverse impacts (PAIs). Additionally, FMPs that provide financial products have further disclosure mandates that they will need to comply with. Specifically, they will have to provide additional website disclosures, as well as pre-contractual and periodic disclosures, where relevant.
The RTS has specified the application of the PAI indicators, where there are 14 mandatory and 46 additional indicators. PAIs are the negative environmental and social impacts that are likely to arise as a result of a financial product or service. The assessment and disclosure of PAIs is intended to help FMPs understand and manage sustainability risks and impacts of their activities and to provide transparency and accountability to investors and other stakeholders. The FMPs are expected to disclose their first PAI statement before 30 June 2023.
Furthermore, financial products that are mandated to disclose under SFDR Article 8 and 9 need to produce pre-contractual and periodic disclosures. The aim of the pre-contractual disclosure is to provide transparency around the characteristics of the product to inform investors and thereby prevent “greenwashing”. On the other hand, periodic disclosures aim to provide historical qualitative and quantitative comparisons, as well as how the financial product meets its objectives as laid out in the pre-contractual disclosure. Sustainability is a journey, and measuring changes over time will help the markets track the progress of investments.
If previously in-scope FMPs could use the “comply or explain” principle, after SFDR level 2, they can no longer go for the “explain” option. In other words, asset managers with more than 500 employees will be mandated to implement due diligence policies and provide qualitative and quantitative disclosures on their websites. This will further enhance the level of sustainability disclosures on the market.
While the application date is fast approaching, there are still some steps FMPs can take to ensure they are prepared for the new requirements. Key actions to consider include whether to consider adverse impacts in their financial strategy. It is also important to assess whether their financial products are in or out of scope of Article 8 and 9 of the SFDR. Depending on the sustainability stance of their financial products, FMPs will need to determine what data is required for compliance with the disclosure requirements. Finally, they should identify, and if necessary, contact their data sources to ensure they have the relevant information for disclosure. By following these tips, FMPs can ensure that they are prepared to meet the requirements of the SFDR ahead of the deadlines. Getting this right is key to avoiding regulatory scrutiny (including fines) and ensuring that stakeholders are well aware of the sustainability credentials.
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