Published: 30 May 2022 · Last updated: 8 Dec 2022
Following new Sustainable Finance Disclosure Regulations (SFDR), Invest Europe* conducted a regulation poll. They found that, as of November 2021, the majority of fund managers were planning on classifying their upcoming funds as Article 8 products.
But why are fund managers choosing to opt for this classification? What is SFDR? And what does it mean to be classified under Article 8?
In a new series of blog posts, our ESG experts will be breaking down the key takeaways from SFDR. We'll be keeping you up to speed and will be outlining SFDR's implications for both fund managers and their portfolio holdings.
We'll provide you with the facts. And we'll also offer advice based on regulatory insights and our first-hand experience helping fund managers to classify their funds under Article 8.
Welcome to our first SFDR blog! Here, we'll summarize what is currently required by SFDR. We'll then introduce the Principal Adverse Impacts (PAIs), which can be measured and tracked using KEY ESG software.
We're on a mission to help fund managers ensure that they're well-informed and prepared accordingly. Some of the upcoming blogs in the series will include more detailed information on PAI indicators. We'll also be taking a closer look at upcoming regulation developments.
SFDR stands for Sustainable Finance Disclosure Regulation. It has become the flagship legislation for the EU’s drive towards increased transparency surrounding sustainable investing. Ultimately, it will apply to all Financial Market Participants (FMPs) marketing their products to EU-based investors.
There are two key aspects to consider when attempting to fully grasp this complex piece of legislation.
Firstly, it is important to note that different entities within an investment firm have different disclosure requirements, whether at an entity-level (or firm-level), a product-level (or fund-level), or an individual asset-level.
Secondly, this regulation is constantly evolving. It is therefore crucial for FMPs to stay up to date on both current and future requirements. This way they can make sure that the necessary steps are taken to collect relevant data. KEY ESG software can help with this.
There are two key stages to SFDR regulation: Level 1 requirements and Level 2 requirements.
Currently, only Level 1 is being enforced. And the implementation of Level 2 has now been delayed by a whole year - until 1st January 2023. This first blog will focus on the current Level 1 disclosures. Future blogs will provide information on the more technical Level 2 requirements. We'll also offer guidance on how to best prepare if you're an asset manager.
Level 1 disclosures apply at both entity-level and product-level. Entity-level requirements are primarily website disclosures, focusing on policies surrounding the incorporation of sustainability risks in investment decisions. Product-level disclosures are more detailed and centre around which of the three following classifications each financial product falls under:
Each classification has different associated disclosure requirements. All funds are automatically classified under Article 6, unless proven otherwise. Naturally, there are further disclosure requirements for Article 8 and 9 funds, as these are the only funds that can advertise ESG features.
For most fund managers, Article 8 classification represents the next logical step towards ensuring that their investment portfolio is sustainable. We have therefore summarized the specific product-level disclosures required to be classified as an Article 8 fund:
A pre-contractual disclosure must outline:
Similar disclosures to pre-contractual disclosures must be prominently available on the fund website.
Additional information should also be readily accessible with regard to:
These disclosures revolve around whether or not the relevant social and environmental fund characteristics are achieved. The disclosures also reveal whether or not any actions have been taken to meet targets associated with these characteristics during the reference period.
The Principal Adverse Impacts (PAIs) form a key part of SFDR regulation. They focus on the measurement of potential negative effects caused by an investment across a range of ESG criteria.
PAI alignment is a key method used to promote the environmental and social characteristics of a product. This can help the product be classified as an Article 8 fund. To date, only a statement regarding the PAIs has been required from large firms (>500 employees). This statement must identify the policies and disclose the associated actions undertaken to manage the PAIs.
However, upcoming Level 2 regulations present a significant challenge to fund managers, due to the additional disclosure requirements of the PAI indicators. These indicators are unique in that they require detailed information from the constituent portfolio assets regarding performance across a range of ESG criteria. As such, the PAI indicators form the backbone of the legislation’s aim to remove greenwashing from financial products.
Fund managers now need to collect relevant ESG data from their portfolio assets to complete their PAIs. Given the extent of the PAI data requirements, which cover ESG criteria ranging from scope 1 & 2 emissions to gender pay equality, the necessary data collection will prove to be a difficult process.
The first report is not required until 30th June 2023, but this will be based on data from 2022. This means that fund managers will need to give their assets a reasonable amount of notice to collect and prepare the appropriate information.
The next blog in this series will focus on these PAI indicators. We'll provide fund managers with a useful resource with which to better understand how to go about collecting the right data.
At KEY ESG, we have incorporated all PAI indicators into our software. This streamlines the process of data collection for fund managers looking to classify their funds under Articles 8/9 in the coming months.
We are entering into a new phase in sustainable investing. Why waste time researching the guidelines when KEY ESG software can set you on the right path from the start? Why stumble through the transition to Level 2 when expert guidance is readily available? KEY ESG's intuitive software provides fund managers with everything they need to make sure they get off to a great start.
For further information or to book a free demo, please get in touch with a member of our team.
*Invest Europe Member Policy Call on SFDR (8th November 2021)