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Compliance

SFDR Requirements: an operational tipping point?

Posted on 10 Aug 2021

Picture of a sprout appearing from the undergrowth

The 10th of March 2021 marked the implementation date of the Sustainable Finance Disclosures Regulation ("SFDR"). SFDR’s implementation creates a requirement where European “financial market participants” and “financial advisers” must disclose specific information regarding their approach to the integration of sustainability, its associated risks and their consideration of adverse sustainability impact in their investment decisions and investment recommendations (regardless of the suitability preference of the end investors).

In short, the SFDR Regulation requires financial market participants and financial advisers to publish disclosures and written policies on the integration of sustainability risks and ensure the transparency of such integration.

There are two levels to SFDR, both with differing disclosure requirements:

  1. Level 1 is the first to be implemented and requires pre-contractual disclosure and website disclosure.
  2. Level 2 requires firms to make periodic disclosures that are more detailed than the level 1 requirements.

Due to the COVID 19 situation, the publishing of the final Regulatory Technical Standards ("RTS") regarding both levels of SFDR has been delayed until 1 July 2022, during this time ESMA has said that the RTS in its current form should be used as guidance by firms and will not be binding until it is adopted next year.

Update: SFDR Delayed for further 6 Months

On the 8th July 2021, the European Commission (“EC”) informed the European Council that the second phase of the SFDR would once again be delayed by 6 months from 1 January 2022 until 1 July 2022. In a letter by John Berrigan, deputy director-general for financial stability, financial services, and capital markets union at the EC he said that the delay would ensure “smooth” implementation.

For the majority of firms, we believe this delay will be welcome as it gives them additional time to comply with a large number of disclosure requirements (read SFDR Requirements section below to find out more) in an already packed regulatory calendar. We also hope that the delay will give the EC additional time to provide clarity on some of the more complex parts of the regulation and amend where necessary.

The report follows several concerns raised by national regulators over failings in the SFDR that relate to firms being able to incorrectly self-certify a large number of their products as meeting enhanced ESG characteristics described in SFDR Articles 8 and 9. It has also been suggested that some firms market their products as more sustainable than they actually are. This tactic sometimes referred to as “greenwashing”, is used to bolster the firm’s ESG ratings or for positive press.  

Is the SFDR applicable to UK firms post-Brexit?

Many of our UK-based clients are wondering if the SFDR will be applicable post-Brexit. Although the UK has not formally confirmed the implementation of the SFDR, the FCA is likely to issue consultation papers and set up an equivelent regime in the UK. More information is expected later in 2021. Whilst today’s implementation of the SFDR does not directly affect UK firms, it is important to consider whether the products or the firm itself is affiliated with EU-based entities or has clients that would be subjected to the new EU regulation. For example, if a firm is a UK manager who may market its fund(s) into Europe under the National Private Placement Regime (‘NPPR’), SFDR will be applicable. SFDR may also affect delegated investment managers if their EU fund manager wishes to apply an ESG approach as part of its requirements.

Why has the SFDR been introduced?

When considering the applicability of SFDR it is important to remember why the regulation was created. The 2020 Trends in Investing Survey reports that ESG funds “increased meaningfully to 38% of advisers currently using or recommending ESG funds in 2020. Nearly one-third (29%) of advisers indicated in the 2020 survey that they plan to increase their use/recommendation of ESG funds over the next 12 months. And almost 40% of advisers indicated that, in the last six months, clients have asked them about investing in ESG funds”. Therefore, the growing demand from investors may affect UK firms in their decision-making as to whether compliance with the SFDR makes commercial sense.

We have seen similar pressures from investors culminating in other governance-focused regulations such as the UK Stewardship Code 2020 which, if a signatory, creates a set of principles for asset management and asset owners related to the responsible allocation, management and oversight of capital to create long-term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society. The 2020 Stewardship code also allows service providers, including investment advisors, to sign up for a shorter list of principles.

While many firms have elected not to implement the Stewardship Code one can see an alignment between the regulatory sustainable and environmental disclosures and investor demand for ESG products and/or ESG considerations related to investment decisions and the asset manager as a whole.

Is the SFDR the tipping point for ESG?

Laven’s pragmatism wonders if the SFDR Regulation represents the tipping point where every UK and EU asset manager and investment advisor should take a step back to create a comprehensive approach to their sustainability and environmental considerations, not just for their SRI product but for all investment and corporate decisions.

The work can represent a significant undertaking, but the holistic approach may save time opposed to responding to each regulatory requirement and investor inquiry and requirement. This holistic approach can involve:

  • Development of an ESG or sustainability policy for investments;

  • Development of an ESG or sustainability policy for the firm as a whole;

  • Product classification assessment;

  • Compliance monitoring procedures to test the controls;

  • Development of disclosures;

  • Product, marketing material and website updates; and/or

  • Investor and regulatory reporting policies and procedures.

SFDR Requirements, Implementation and Timeline

Firms wishing to only comply with the SFDR requirements have a number of obligations.

Compliance with the requirements includes, amongst other things, obligations to conduct:

  • Product classification assessment to determine relevant disclosures (regardless of whether the products have an ESG focus);
  • Assessments of the asset managers firm-wide compliance with the regulation;
  • Development of website and product disclosures;
  • Development and updating of periodic disclosures;
  • Updates to compliance monitoring plans; and
  • Compliance monitoring procedures to test controls and compliance.

The SFDR implementation of level 1 requirements is scheduled to come into effect today, 10th of March 2021, with the implementation of level 2 requirements scheduled for 1 July 2022.  We expect to see further updates from the FCA throughout the first half of 2021 with a potential implementation date secured for 2022 for large firms and 2023 for smaller firms. We will continue following the FCA’s consultation on the implementation of the SFDR into UK regulation.


How can we help?

If ESG and the principles the SFDR aims to establish affect your existing or potential activities Laven can assist your firm with the proportionate implementation of the SFDR, policy documents and disclaimers.

At Laven, our consultants are on hand to help identify the actions your firm needs to take to ensure you are compliant with the new regulation outlined in this report. Whether this is through assisting with new policies and procedures that need to be put in place or providing online/in-person training for staff to fully understand the regulatory obligations.

Laven has also built Laven Tech, a unique Regulatory Technology (RegTech) solution that leverages advanced technology combined with our vast subject matter expertise. Our RegTech solution is designed to assist fund managers, service providers, and investors in meeting today’s growing demands.

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