The European Union Sustainable Finance Disclosure Regulation (SFDR) Level 2 took effect on January 1st, 2023. This regulation builds upon EU taxonomy regulation SFDR Level 1, enforced in June 2021. Investment firms must display a public statement regarding principal adverse impact (PAI) and due diligence policies on their website. The new rules necessitate fund providers to give total disclosure obligations concerning sustainability related topics, such as sustainable investment objectives and sustainability risks, along with completing compulsory reporting templates.
Level 2 mandates a higher level of detail in the PAI statement by outlining 14 core indicators and 31 extra components, with organizations required to provide insight on all 14 fundamental elements as well as at least two additional, one of which must be focused on governance or social characteristics like human rights, anti corruption, anti bribery matters and remuneration policies. At the same time, another needs to possess environmental factors such as sustainability risks and climate change.
Despite the European Commission's new regulations on transparency and disclosure, there needs to be clarity surrounding Article 9 funds' requirements for sustainable investment. In June of 2022, the European Commission clarified any doubt by explaining that financial products with a sustainability objective should only be making sustainable investments. Despite this movement towards clarification, uncertainty remained in the months following, leading to an abundance of downgrading active and passive Article 9 funds as a safe precautionary measure.
The Sustainable Finance Disclosure Regulation regulations aim to force them to provide more visibility to investors and other financial market participants by mandating asset managers to be more transparent than ever about their ESG (environment, social and governance) practices and decision outcomes. The Sustainable Finance Disclosure Regulation is a disclosure program. Yet, it provides investors and financial advisers with tangible indicators of sustainability objectives and risks for sustainable investment products via key performance metrics in its annexes. Depending on which Article (6, 8, or 9) applies to any given product dictates what information needs to be disclosed in detail.
Asset managers and other financial market participants must now adhere to higher levels of transparency than before or face the consequences. Non-compliance with these new rules can result in reputational damage and potential legal action from European supervisory authorities, which is why many asset managers are becoming more transparent in their ESG practices and outcomes. These measures have been challenging to implement for some firms, especially those who are behind schedule or need help with how to proceed.
Introducing the regulatory technical standard (RTS) is a positive step towards increased clarity. The RTS clarifies what information must be disclosed and how to report it accurately. This clarity has helped many firms to comply with the new rules effectively. However, there is still some confusion surrounding disclosures of Article 9 funds, which need to be clarified further to increase transparency and prevent misunderstandings in the investment decision making process.
Despite the challenges, many in the industry view the Sustainable Finance Disclosure Regulation (SFDR) regulations as a significant step towards more visibility in the financial sector and a sustainable economy. The rules promote clarity and disclosure, which can help investors and financial advisers make more informed decisions about their investments. In the long run, this can benefit financial market participants such as investors, financial advisers and asset managers.
The Sustainable Finance Disclosure Regulation Level 2 regulations represent a significant step towards increased clarity, sustainable finance and disclosure in the financial industry. While challenges remain, introducing the regulatory technical standard is a positive step toward ensuring compliance with the new rules.
As firms strive to comply with these measures, we can help those struggling with the new European regulation to ensure they meet their obligations and avoid potential legal action.