The Sustainable Finance Disclosure Regulation (SFDR) is a ground-breaking initiative implemented in the European Union (EU) on 10th of March 2021 to drive sustainable and responsible investments within the financial sector.
While SFDR is not exclusive to the aviation industry, it has significant implications for aviation companies, given the sector’s environmental impact and its increasing focus on sustainability.
This guide covers:
- What is SFDR?
- What is the objective of SFDR?
- Who does SFDR apply to?
- Is SFDR mandatory?
- The Benefit of SFDR in Aviation
- Consequences of non-compliance
- What are SFDR disclosure requirements?
- SFDR disclosures at the entity and product level
- SFDR product classification: Articles 6, 8 and 9
- SFDR Timeline
- How to report on SFDR?
What is SFDR?
SFDR stands for Sustainable Finance Disclosure Regulation (SFDR) is a set of ESG (Environmental, Social, and Governance) disclosure obligations for all Financial Advisors (FAs) and Financial Market Participants (FMPs) based in or trading in the EU. The regulation came into effect on the 10th of March 2021.
What is the objective of SFDR?
The objective of SFDR is to change the financial sector’s behaviour when making ESG-related claims, promote sustainable and responsible investments, and ensure investments do no significant harm to the EU’s environmental objectives in the fight against climate change.
SFDR works by standardising ESG disclosures through comprehensive sustainability disclosure requirements covering a broad range of ESG metrics at both entity and product levels.
SFDR requires financial market participants (FMPs) to be more transparent about their sustainability efforts and ensure they are not engaging in “greenwashing.” By providing clear and accurate information, SFDR aims to empower investors and customers to make more informed decisions about their investments and encourage the industries to transition towards more sustainable practices.
The regulation applies to all financial market participants (“FMPs”) and financial advisors (“FAs”) in the EU, FMPs with EU shareholders, and those marketing themselves in the EU, and sets out clear disclosure requirements.
- An insurance company that makes available an insurance-based investment product
- Investment firms that provide portfolio management
- An institution for occupational retirement provision
- A manufacturer of pension products
- An alternative investment fund manager
- A pan-European personal pension product provider
- manager of a qualifying venture capital fund
- A manager of a qualifying social entrepreneurship fund
- A management company for UCITS (Undertakings for the Collective Investments in Transferable Securities)
- A credit institution that provides portfolio management
It applies also to the financial products such as: investment and mutual funds, UCITS, insurance-based investment products, private and occupational pensions and insurance and investment advice.
Is SFDR mandatory?
Yes, SFDR is a mandatory regulation for EU-based financial market participants and financial advisors, effective since March 2021. The SFDR Level 2 requirements took effect on January 1, 2023.
The Benefit of SFDR in Aviation
SFDR benefits the aviation industry by promoting transparency, encouraging sustainable investments, mitigating greenwashing, and supporting the EU’s environmental objectives. Compliance with SFDR requirements can enhance the industry’s reputation, attract responsible investors, and contribute to a more sustainable future for aviation.
Consequences of non-compliance
Non-compliance with SFDR may result in penalties and reputational risks for aviation companies. It is essential for the industry to adhere to the regulation to demonstrate their commitment to sustainability and responsible investing.
What are SFDR disclosure requirements?
SFDR which aims to increase transparency and comparability among financial institutions and their products has the following SFDR disclosure requirements:
- Financial entities have to disclose how they integrate sustainability factors into their decision-making process and what adverse impacts their financial products have on society and the environment.
- Disclosure requirements cover three different scopes: entity-level disclosure requirements, product-level disclosure requirements, and reporting.
- Entity level disclosures refer to disclosure obligations for the entities themselves concerning their policies on decision-making on sustainability risks.
- Product level disclosures refer to reporting obligations concerning the financial products and their sustainability risks.
- The SFDR classifies financial products into three categories as described in Articles 6, 8, and 9 of the legislation.
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SFDR disclosures at the entity and product level
The key distinction made in the SFDR disclosure requirements is the separation of entity level disclosures from product level disclosures
Entity level disclosures (also known as SFDR level 1 disclosures):
Refer to disclosure obligations for the entities themselves concerning their policies on decision-making on sustainability risks. These disclosures include the integration of sustainability risks in investment decisions, investment decisions’ adverse effects on sustainability, and alignment with the EU Taxonomy.
SFDR level 1 disclosures requires FMPs to undertake a series of disclosures on their sustainability practices:
- Sustainability risk policy: How an entity integrates sustainability risks in its financial advice or investment decision‐making process.
- Principal Adverse Impact (PAI): How their investments impact sustainability considerations.
- Sustainability risk remuneration policy: How remuneration policies take sustainability risks into account.
There are 14 different entity-level sustainability factors FMPs must disclose, ranging from greenhouse gas emissions to social impact. FMPs that don’t consider sustainability in their investment decisions must clearly state this on their website, along with an explanation for why.
Product level disclosures (also known as SFDR level 2 disclosures):
Refers to reporting obligations concerning the financial products and their sustainability risks. Not only are financial market participants obligated to disclose information about their sustainability practices. But they also must disclose information about each product that they market to clients in the EU.
SFDR level 2 disclosures requires FMPs to adopt a further series of disclosures for each of the financial products they make or market. There are different categories for financial products:
- Mainstream: For FMPs that do consider PAIs (Principal Adverse Impacts), an explanation of how financial products account for these impacts should be provided. This applies to all the FMP’s products, whether they are intended to meet sustainability goals or not.
- Promoting environmental or social characteristics: For ‘Article 8’ products that promote ‘environmental’ or ‘social’ characteristics, there must be additional information on how these are met, including disclosure on the degree of EU Taxonomy alignment of underlying economic activities.
- Having sustainable investment objectives: For ‘Article 9’ products that have a sustainable investment objective, firms must provide an explanation on how the objective is achieved, as well as additional disclosure on alignment with the EU Taxonomy Regulation.
SFDR product classification: Articles 6, 8 and 9
Under the Sustainable Finance Disclosure Regulation (SFDR), financial products are separated into three different categories: Article 6 funds, Article 8 funds, and Article 9 funds.
- Article 6 funds – are financial products that do not have any sustainability drivers.
- Article 8 funds – promote investments or projects with positive environmental or social characteristics and with good governance principles, alongside other non-ESG traits.
- Article 9 funds – also known as “dark green products” have sustainable investment as their objective.
Article 6 of the SFDR is part of Level 1 disclosure (i.e. entity level disclosures). It requires financial market participants to include descriptions of the integration of sustainability risks in their pre-contractual disclosures.
While, Article 8 or 9 funds that promote ESG product are subject to Level 2 RTS (Regulatory Technical Standards). The SFDR Level 2 requirements came into effect on January 1, 2023. The Regulatory Technical Standards (RTS) under SFDR Level 2 are a set of detailed requirements that supplement the Level 1 measures and provide a comprehensive sustainability disclosure requirement covering a wide range of environmental, social, and governance (ESG) factors.
The RTS specifies the content, methodologies, and presentation of information relating to sustainability indicators and adverse sustainability impacts, the principle of “do no significant harm,” and the promotion of environmental or social characteristics and sustainable investment objectives in pre-contractual documents, on websites, and in periodic reports.
The SFDR timeline outlines the significant milestones
- March 10, 2021: SFDR was signed into effect.
- June 30, 2021: Key date for the beginning of SFDR.
- January 1, 2022: Financial market participants (FMPs) must disclose key indicators from this date through December 30, 2022.
- December 30, 2022: End of the reference period for the first PAI statement.
- January 1, 2023: SFDR Level 2 implementation begins.
- June 30, 2023: Reporting deadline for the first Principal Adverse Impact (PAI) statement.
- January 1, 2024: Start of financial years subject to SFDR requirements.
How to report on SFDR?
Reporting on SFDR involves providing comprehensive disclosures on sustainability-related information at both the entity and product levels. Here are the key steps to consider when reporting on SFDR:
- Understand SFDR requirements: Familiarize yourself with the SFDR regulations and the specific disclosure obligations applicable to your organization.
- Collect relevant data: Gather the necessary data on sustainability factors, including environmental, social, and governance (ESG) metrics, to support your disclosures.
- Assess adverse impacts: Calculate and assess the principal adverse impacts (PAIs) of your investments on sustainability, considering climate-related and other ESG factors.
- Prepare entity-level disclosures: Disclose how your organization integrates sustainability factors into its decision-making processes and the adverse impacts of your financial products on society and the environment.
- Prepare product-level disclosures: Provide detailed information about each financial product, including its sustainability characteristics, ESG risks, and alignment with the EU Taxonomy, if applicable.
- Use reporting templates: Utilize the mandatory reporting templates to structure and present your disclosures in a standardized format.
- Ensure accuracy and transparency: Ensure that your disclosures are accurate, transparent, and avoid any misleading information or “greenwashing” practices.
- Seek expert advice: Consider seeking regulatory advice or consulting with experts to ensure compliance with SFDR requirements and best practices.
By following these steps, companies can effectively report on SFDR, demonstrating their commitment to sustainability and providing transparent information to investors and other stakeholders.
The Sustainable Finance Disclosure Regulation (SFDR) is a ground-breaking initiative introduced by the EU to promote sustainable and responsible investments within the financial sector. By enforcing clear and comprehensive disclosure obligations on Financial Market Participants (FMPs) and Financial Advisors (FAs), SFDR aims to improve transparency, prevent greenwashing, and direct capital towards sustainable growth.
Through standardized ESG disclosures at entity and product levels, SFDR empowers investors to make informed decisions, encourages sustainable practices, and supports the EU’s environmental objectives in the fight against climate change. Complying with SFDR requirements is essential for financial entities operating within the EU to demonstrate their commitment to sustainability and avoid potential penalties for non-compliance.