What is SFDR?
The Sustainable Finance Disclosure Regulation (SFDR) imposes mandatory ESG disclosure obligations for asset managers and other financial markets participants with substantive provisions of the regulation effective from 10 March 2021. It strives to help transition to a sustainable, energy-efficient, net-zero society. The regulation focuses on pre-defined metrics for assessing the environmental, social and governance (ESG) outcomes of the investment process. As its name suggests, much more emphasis is being placed on disclosure, including new rules that must identify any harmful impact made by the investee companies.
SFDR was introduced alongside the Taxonomy Regulation and the Low Carbon Benchmarks Regulation as part of a package of legislative measures arising from the European Commission’s Action Plan on Sustainable Finance.
The Objective of SFDR
The EU can implement measures to ensure that all countries meet a minimum standard but inconsistencies in both financial and sustainable efforts are bound to occur. Therefore, the main goal of SFDR is to bridge the gap between these potential discrepancies regarding disclosures.
SFDR is dedicated to reducing several inconsistencies, such as sustainability risks, the impact of existing sustainable measures, how a company’s environmental or social characteristics are perpetuated to current or future customers or investors, and how investments are made in a sustainable manner. Those legally required to participate in the SFDR have to disclose these activities to investors to prevent public allegations and predicaments. They hope to ultimately make this contribute to a sustainable future for the European Union.
Who must Comply with SFDR?
SFDR applies to financial market participants (FMPs) and financial advisors within the EU. This includes pension funds, asset managers, institutional investors, insurance companies, and pension funds, among others.
Financial market participants with fewer than 500 employees are not required to produce a principal adverse impact statement. However, they are obligated to explain why.
So, in short:
Although SFDR is an EU regulation, funds that are located outside the EU but are marketed in Europe also fall under this disclosure requirement.
When to Comply with SFDR?
SFDR was introduced on March 10th, 2021.
From January 1st, 2022, companies covered by SFDR need to begin reporting their Principal Adverse Impact.
On the 1st of January 2023, the Regulatory Technical Standards (RTS) come into force with Level 2 requirements, known as "SFDR Phase II" or "SFDR Level 2".
SFDR Article 6,8 & 9
With asset managers having to disclose the different levels of sustainability integration, the SFDR is categorized into Articles. The main ones are Articles 6, 8 and 9.
A fund will either be classified as an article 6,8 or 9 funds depending on its nature and the level of sustainability:
Article 6: Funds with no sustainability scope
Article 8: Funds that promote environmental and social characteristics
Article 9: Funds with sustainable investment as their objective
SFDR Article 6
Article 6 is the default classification for funds and the one most appropriate for those with no ESG focus. This means funds that neither have a sustainable investment objective nor do they embrace investment in assets with environmental or social benefits.
In this classification, the incorporation of sustainability risks into investment decision-making and the impact of sustainability risks on fund returns must be described in the fund's prospectus (AIF) or Private Placement Memorandum (PPM). Where a fund manager does not consider sustainability risk in the decision-making process, the disclosure should explain why under the principle of comply or explain.
SFDR article 8
Under SFDR, Article 8 products promote investments or projects with positive environment or social characteristics and with good governance principles, alongside other non-ESG traits. Such promotion could include screening out certain environmental and socially harmful investments or considering ESG ratings when making investment decisions. If the investment product has a benchmark, the FMP must disclose whether the benchmark is consistent with the product’s promoted characteristics.
While sustainable investment is not an objective of the product, it remains an aspect of the investment process. Article 8 products need to disclose the degree (if any) to which they invest in environmentally sustainable investments or in investments with a social objective, as set out by EU Taxonomy regulations.
So, article 8 applies to funds promoting environmental and social objectives and which take more into account than just sustainability risks as required by article 6.
However, article 8 funds don’t have ESG as core objectives – as required for becoming labeled an article 9 fund.
SFDR article 9
For a fund to comply with SFDR Article 9 a financial product should have sustainable investment as its objective. A benchmark index which aligns with the fund objective must also be chosen. The benchmark will then be used to measure the achievement of the fund's sustainable investment objective.
Compared to article 8 funds, which should promote environmental or social characteristics and have good governance practices, article 9 funds should positively impact society or the environment through sustainable investment and have a non-financial objective at the core of their offering.
How Alphavalue can help
According to Morningstar, at least $85 billion in industry-wide Article 9 funds will have been downgraded to Article 8 or less within the coming weeks and months. The reason is simple: regulatory guidance is becoming more stringent, and many asset managers are not ready to meet the challenges set by implementing these new norms.
We believe we can help with SFDR: we do it simply, thoroughly, and transparently
AlphaValue provides SFDR-type reporting on all its current coverage of c.550 European stocks at a click that covers most investment strategies, equity and debt. For existing clients, this service is built into AlphaValue research services at no cost, saving massive management time and avoiding considerable costs for advice, audit, expertise, and databases. Not only can AlphaValue offer SESG data, but also a dynamic view of the SESG ratings: Example - ‘22 vs ‘21 or last 6 months vs today and written content on each holding of a portfolio to explain the scores.
Implementing ESG is really demanding. AlphaValue took a strong stance on the issue by going solo 14 years ago: we have our own set of data, use our own algorithms and a no-exclusion approach. More importantly, our opinions are supported by our absolute independence. Over the years, AlphaValue has developed an approach that ties up fundamental research and valuation with ESG metrics on a continuous and live basis. To the best of our knowledge, there is no equivalent in the brokerage and data provider fields.
Therefore, by using AlphaValue tools, SFDR requirements can be met up to Article 8. Thanks to our portfolio analysis tool using our proprietary ESG data, reporting is made easy, sincere and fully backed by genuine fundamentals checked by genuine full-fledged analysts. AlphaValue SFDR results can be audited at will.
Example of how a virtual portfolio looks like (it can be customized and data can be downloaded):
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