Sustainable Finance Disclosure Regulation - are you ready?

The Sustainable Finance Disclosure Regulation (“SFDR”) will come into force on 10 March 2021 in the EU – less than 4 months to go. Until recently the market expectation and preparation had been predicated on the assumption that SFDR would apply in the UK. We now know that this is not the case. For many clients, this has added a layer of confusion to their preparation.

Reminder of the high level impacts:

SFDR requires all AIFMs, UCITS management companies, and MiFID firms providing the service of portfolio management to make certain pre-contractual, website and periodic disclosures on various sustainable investment issues. At a high level, these include:

• For all relevant entities: how the entity integrates sustainability risks into the investment decision making process, how the entity takes account of the principal adverse impacts of investment decisions on sustainability factors (on a comply or explain basis) and how their remuneration policies are consistent with the integration of sustainability risks.
• For all relevant products: remember that all of your products are captured – not only those with an ESG focus. All products will need to disclose the likely impacts of sustainability risks on the returns of the product (or explain why such risks are not considered relevant). If the relevant entity is complying with the principal adverse impacts requirements, each of that entity’s products will also need to disclose whether and how it considers the principal adverse impacts on sustainability factors.
• For ESG focussed products: products that promote environmental or social factors (Article 8) or have a sustainability objective (Article 9) have additional disclosures to be made, following detailed frameworks set out in the Level 2 regulation.

Three key points to note now:

Remember the UK! Although SFDR will not be directly applicable, your UK operations may still be indirectly caught – for example in the following circumstances:

• if you will continue to market your funds into the EU as of 1 January 2021
• if your firm is the sponsor/investment manager of EU funds operated by a third party AIFM – in practice the relevant SFDR requirements will fall to you but you will need to engage quickly with your third party AIFM to discuss and agree an approach
• if, as we have seen with a number of clients, your firm is part of a group that has decided on a global basis to implement SFDR as a baseline commitment to effective ESG disclosure – meaning their entities and funds can be aligned with those in the EU. Many clients consider this to be a key commercial imperative, reflecting the needs of their investors.

Don’t underestimate the preparation involved. Compliance with SFDR is a time intensive task, bespoke to every entity and product. Although framed as requiring only disclosures, it in practice requires firms to make strategic business and policy decisions – which will then need to be disclosed. It is not possible simply to include a standard disclosure in your prospectuses or PPMs or on your websites.

Be aware of the implications of the Level 2 delay. The SFDR disclosures outlined above are supplemented by Level 2 measures, which set out in much greater detail what firms need to disclose at both an entity and a product level. These include a number of highly detailed and scientific metrics, many of which would have been impossible to obtain and disclose by 10 March 2021. Following industry feedback, the European Commission has confirmed that compliance with these more onerous requirements will be delayed – probably until January 2022. Although this is good news for now, it does not remove the issue entirely. The main requirements will still apply and so these will need to be dealt with on a best efforts, principles based approach. Practically this is a challenge as:

• you will have to consider how best to approach these disclosures on a more narrative, qualitative basis;
• it effectively means a two-stage compliance, with updates required again when Level 2 comes into force; and
• the data problem of how to source the required disclosures remains an issue for the industry as a whole.

How we can help

We are advising many of our clients across Europe on the implementation of SFDR and have an expert team across all fund types and asset classes. We can assist in many ways depending on your internal needs and resourcing, including:

• assisting with scoping out how your firm and products will be affected by SFDR, including analysis for determining whether a particular product will fall under Article 8 or Article 9
• providing detailed frameworks for compliance with the various disclosures
• assisting with the drafting of the relevant policies and disclosures
• general support with the business in understanding the far reaching effects of SFDR and identifying any gaps in our existing ESG materials