Introduction to the European Sustainable Finance Disclosure Regulation SFDR

Introduction to the Sustainable Finance Disclosure Regulation

The Sustainable Finance Disclosure Regulation (SFDR) is a key pillar of the EU sustainable finance action plan and was first proposed in November 2019 (from Regulation (EU) 2019/2088). The EU mentioned in the document that with issues related to sustainable development such as climate change, not only public policies need to play a role, but also the financial sector needs to promote the allocation of capital to sustainable areas.

SFDR aims to clearly disclose the content of funds that claim to be sustainable or have sustainable characteristics, thereby helping investors compare sustainable products and promote the decarbonization of investment portfolios. Effective from March 2021, Financial Market Participants (FMPs) with more than 500 employees in the EU are required to disclose sustainable development policies and the adverse impact of investment decisions on sustainable development factors (Principal Adverse Impacts, PAI). In the current context where the development of sustainable finance is still immature, SFDR is still in the early stages of regulation.

SFDR marks 18 mandatory PAI indicators (such as greenhouse gas emissions) and 46 voluntary PAI indicators, and FMP must disclose these mandatory indicators. Although the first deadline for mandatory PAI information disclosure to take effect is June 2023, there are still many asset management companies that fail to disclose information as required, and there are deficiencies in disclosure standards and disclosure scopes.

SFDR Level 1 and SFDR Level 2

SFDR Level 1 and SFDR Level 2 come from the SFDR Regulatory Technical Standards (RTS) released in January 2022. When the SFDR was initially released in March 2021, it only required FMPs to disclose sustainable issues on their website, without providing a specific disclosure template. It also required FMPs to adhere to comply or explain principle.

In January 2022, SFDR-RTS continued to specify the rules of SFDR, providing pre-contractual disclosure documents and periodic reporting templates for financial products, as well as entity-level PAI information disclosure templates, which marks the SFDR Level 2. These templates demonstrate to investors the sustainability performance of FMP and the sustainability characteristics of its products. At the same time, FMP needs to meet the requirements for mandatory disclosure, and SFDR Level 2 has made significant progress in the information disclosure requirements.

Timeline of Sustainable Finance Disclosure Regulation

• March 10, 2021: SFDR Level 1 takes effect.
• June 30, 2021: FMP is required to disclose PAI information on the website.
• January 1, 2022: The first consultation period for SFDR-RTS begins.
• April 6, 2022: SFDR-RTS is adopted.
• January 1, 2023: RTS disclosure templates are included in mandatory use, and SFDR Level 2 takes effect.
• February 17, 2023: RTS begins to be revised.
• April 12, 2023: Financial Supervisory Authorities (ESAs) issued a consultation document on the revised RTS.
• June 30, 2023: FMP submits PAI documents based on 2022 data.
• July 4, 2023: The consultation period for SFDR-RTS expires.
• December 4, 2023: The revised SFDR-RTS is officially released.

SFDR’s Relationship with Other EU Regulations

As part of the EU’s regulatory framework for sustainable finance, Sustainable Finance Disclosure Regulation is related to the EU Taxonomy. The EU taxonomy defines sustainable activities as those that comply with one of six specific environmental objectives and do not cause significant harm to other objectives. The FMP is required to disclose whether investment products comply with EU taxonomy and add a statement on non-sustainable activities.

Therefore, SFDR’s sustainable disclosure is based on the sustainable activities defined by the EU taxonomy, and the two together simplify the disclosure of sustainable information. This feature is like the EU Corporate Sustainability Reporting Directive (CSRD). The difference between CSRD and SFDR is that the former focuses on company-level disclosures, while the latter focuses on investment product-level disclosures.

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