EU statements on combating climate change and global warming show a resolute and commendable ambition. This ambition has been formalized as part of the European Union’s Green Deal, which aims to achieve carbon neutrality by 2050. This requires far-reaching changes to our economic structures. Public funds may not be sufficient to finance these transformations. Private assets must also flow into activities that contribute to a more sustainable future. Many investors are already reaping the benefits of a more sustainable investment.
The European Commission wants to encourage this development and is developing regulations to create additional incentives and harmonize standards and disclosures for sustainable investments. The EU’s Sustainable Finance Action Plan introduced initiatives such as the Sustainable Finance Disclosure Regulation (“SFDR”) 1, EU classification, sustainability standards and environmental labels.
As of March 2021, the SFDR is gradually coming into effect. Following the introduction of SFDR Level 1, the SFDR Level 2 Regulatory Technical Standards (RTS) has been published, which will be mandatory from January 2023. Preparations for SFDR Level 2 are in full swing. By fall 2022, the SFDR and EU classification will be incorporated into MiFID II, and the UCITS and AIFMD (Alternative Investment Fund Managers Directive 2011/61/EU) guidance will be incorporated through EU-mandated actions.
Through this series on the changing regulatory environment for sustainable investment in Europe, we aim to keep you informed of the latest regulatory developments and their implications, and to provide insights into how to stay in control in this uncertain and changing environment. We present five things you should know about the SFDR and the EU classification.
1. From SFDR Level 1 to SFDR Level 2
First of all, the Social Fund for Development and Cooperation must create a common understanding regarding the sustainability of financial market participants and financial products. Disclosure and Common Principles aim to reduce confusion, heterogeneity, and greenwashing in sustainable investing. SFDR applies both at the company level, i.e. to the participants in the financial market, and at the product level. Importantly, SFDR formalizes the principle of double materiality. It takes into account the significant financial sustainability risks faced by the company or product, as well as the impact of the company or product on the environment and society.
As is usual with the implementation of EU regulations, the framework’s ambitious principles were introduced with Tier 1 in March 2021. Financial market participants must now disclose their strategies for dealing with sustainability risk and explain how to incorporate sustainability into their reward guidelines. Certain product-level disclosures, often qualitative, must also be made according to participants’ ratings of products.
The SFDR defines three categories of financial products, in Article 6, Article 8, and Article 9. Article 6 products only take sustainability in terms of managing environmental, social and corporate governance risks, Article 8 products consider sustainability aspects, and Article 9 products have clear sustainability goals. The legal text is somewhat more detailed, but the definition of the categories is mostly qualitative and open to interpretation.
In April 2022, the European Commission (EC) published the much awaited regulatory technical standards for SFDR Level 2, providing further guidance on content, methods and information presentation. They include, for example, forms for pre-contractual disclosures and periodic recurring disclosures for Article 8 and Article 9 products (even information on the website is taken into account).
For more details on the important new policies, broken down into the following four points, read on over here.