March 8, 2024


What is the SFDR? A Focus on the Sustainable Finance Disclosure Regulation

What is the SFDR? A Focus on the Sustainable Finance Disclosure Regulation

The Sustainable Finance Disclosure Regulation (SFDR) is a European Union regulation that came into effect in March of 2021 to increase transparency and accountability in the financial market so investors can make clear decisions based on factual data about supporting companies with regards to ESG factors whether or not ESG is their primary focus. 

The SFDR requires financial market participants (FMPs) and financial advisors (FAs) in the EU to disclose specific information through SFDR classifications on how they integrate ESG risks into their investment decisions and advisory processes.

What is more, implementing the SFDR contributes to the EU’s alignment with the Paris Agreement and makes it easier to prevent greenwashing. It also shifts the focus towards investing in the green economy. 

Who does SFDR apply to?

  • Financial market participants or financial advisors
  • Non-EU firms that target the EU market through the Alternative Investment Fund Managers (AIFM) Directive
  • Entities with 500+ employees

SFDR reporting requirements

There are entity-level and product-level disclosure requirements. 

  • First, we’ll cover entity-level disclosures and the details that follow. 
  • Next, we’ll cover product-level disclosures and the SDFR classifications articles 6, 8, and 9 that are required under that level.

Entity-level disclosures 

These (Article 4) disclosures are based on a “comply or explain” basis stating that FMPs must decide if they consider the principal adverse impacts on sustainability factors of these particular investments, and include a statement on their due diligence policies in regard to such impacts. FMPs which do not consider these PAIs are obliged to explain why and if it’s necessary to consider them in the future.

Here are the key components of entity-level disclosures under the SFDR:

1. How firms factor in the integration of sustainability risks regarding their investment decision-making process or investment advice. This includes how those risks are identified, assessed, and managed, as well as the expected impact of these on the returns of the financial products they offer.

2. Financial market participants are required to disclose the Principal Adverse Impacts (PAI) of investment decisions on sustainability factors. A detailed statement is required for both entity and product disclosures, outlining how these impacts are considered, the actions taken to address them, and the outcomes of such actions. 6 out of 14 mandatory PAI indicators are climate-related. 2 additional PAI indicators must be chosen out of 46 voluntary indicators.

3. Entities must describe how their remuneration policies are consistent with the integration of sustainability risks. This is intended to show whether incentives for staff are aligned with sustainable investment objectives.

4. Much of the entity-level information must be published on the firm's website, ensuring accessibility and transparency for investors and the public. This includes the firm's policies on the integration of sustainability risks, the consideration of principal adverse impacts on sustainability factors, and if applicable, information on their adherence to internationally recognized standards for due diligence and reporting.

Product-level disclosures

Products could apply to different topics such as the Undertakings for Collective Investment in Transferable Securities (UCITS), which is the EU’s framework for the management and selling of mutual funds, which are well-regulated investments.

The SFDR categorizes financial products into three main classifications based on their sustainability characteristics or objectives, and each SFDR classification requires articles of disclosure which we’ll discover in detail in the next section.

SFDR classifications 

A summary of what we’ll explain below:

Article 6: Funds that aren’t focused on sustainability

Article 8: Funds that highlight the ES (environmental or social characteristics) in ESG which are referred to as light green

Article 9: Funds that promote sustainable investment at their core which are referred to as dark green

SFDR article 6 products

These products don’t hold sustainability at their center according to the Green Taxonomy, but those reporting on SFDR must disclose how sustainability risks are integrated into their investment decisions and the likely impacts of sustainability risks on the returns of the product. These do not integrate sustainability into their investment decisions beyond the basic level of ESG risk assessment.

For such products, if there is no PAI compliance, there must be an explanation in a statement as to the sustainability impact that will happen as a result of the product on this business and inevitably how that would impact the investment.

SFDR article 7 

According to Deloitte article 7 adheres to, “Disclosure on a product-level (article 7 SFDR), by publishing PAI information in pre-contractual financial product documentation, such as fund information memoranda or prospectuses, this requirement applies to financial market participants only.”

SFDR article 8 products (light green products)

  • Promotes environmental or social characteristics: Products that promote environmental and social characteristics, where those characteristics are not the overriding objective. The managers of these products must provide detailed information about:
  • The environmental or social characteristics promoted by the product.
  • The investment strategy and how it aligns with those characteristics.
  • The methodologies used to assess, measure, and monitor the environmental or social characteristics.
  • The sustainability indicators used for these products.
  • How the product adheres to the "do no significant harm" principle.

SFDR article 9 products (dark green products)

  • Sustainable investment objective: Products with an explicit sustainable investment objective or that aim to reduce carbon emissions. The disclosures for these products are more stringent, requiring:
  • Detailed information on the sustainable investment objective.
  • How the product aims to achieve this objective.
  • The methodologies used for assessing, measuring, and monitoring the impact of the investments.
  • Information on the use of sustainable indicators and the application of the "do no significant harm" principle.
  • Where applicable, information on how the product contributes to environmental or social objectives, including a qualitative and quantitative explanation of the impacts.

Common disclosure elements for article 8 and article 9 products

  • Pre-contractual disclosures: Information about how the product meets its sustainability characteristics or objectives must be included in pre-contractual documents. (Article 7)

  • Periodic reports: These products must provide periodic reports detailing the extent to which environmental or social characteristics are met or how the sustainable investment objective is achieved.

  • Website disclosures: Detailed information on sustainability strategies, including the product's sustainability indicators, criteria for aligning with environmental or social characteristics, and the methodologies used, must be available on the firm's website.
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What are Principal Adverse Impact disclosures under the SFDR?

PAI disclosures specifically require entities to report on how their investment decisions have adverse impacts on sustainability factors. These sustainability factors include environmental, social, and employee concerns, respect for human rights, and anti-corruption and anti-bribery matters. The aim is to provide end investors with clear information on the sustainability impact of their investments, helping to promote more sustainable investment choices. These disclosures must be clear on websites and on pre-contractual information. 

PAI disclosures are detailed and require reporting on a set of mandatory indicators for all financial market participants and advisers who are subject to the regulation, regardless of their size. For larger entities (those with more than 500 employees), additional and more detailed disclosures are required. The indicators cover a broad range of issues, such as greenhouse gas emissions, water consumption, waste production, and impacts on biodiversity, as well as social and employee matters, human rights, and anti-corruption practices.

Entities required to comply with the PAI disclosures must collect data, assess their investments against the set indicators, and report annually on their findings. This process involves a significant effort in data collection, analysis, and reporting to meet the regulatory requirements. The disclosures are designed to encourage more responsible investment practices and to ensure that investors have access to the information needed to make informed decisions based on sustainability criteria.

There are PAI templates supplied by the SFDR in order to assist in what should be included.

The PAI publication deadline is 30 June 2024 for the data of the calendar year of 2023. SFDR delegated regulation applies.

What are the mandatory 14 PAI indicators?

6 climate-related PAIs

  • Scope 1, 2, and 3 GHG emissions
  • GHG intensity
  • Carbon footprint
  • Share of investment in companies active in the fossil fuel sector
  • Share on non-renewable energy consumption and production
  • Energy consumption intensity per high-impact climate sector

8 ESG-related PAIs outside of climate

  • Hazardous waste ratio
  • Emissions to water
  • Activities negatively affecting biodiversity - sensitive areas
  • Violations of UN Global Compact Principles and OECD Guidelines
  • Lack of process and mechanisms to monitor compliance with the former indicator
  • Gender pay gap
  • Board gender diversity
  • Exposure to controversial weapons

How Net0 can help with SFDR climate-related data

Net0 transcends traditional carbon calculation methods, offering an AI-enhanced GHG emissions management platform leveraged by businesses and governments to make action plans on their carbon mitigation strategies. With a growing consumer demand for environmentally friendly products and services, alongside investor needs for concrete, long-term climate data on ESG progress, emissions reporting has become an essential, non-negotiable aspect of operating within the climate-conscious economy.

Utilizing automation, Net0 captures raw data and converts it into quantifiable emissions data across all 3 scopes, facilitating precise tracking so reports are precise and accurate in real-time. Its rapid analysis, incorporating over 50,000 emissions factors, empowers organizations to formulate and implement targeted strategies to reduce carbon emissions. This results in verifiable, audited carbon reporting that meets the standards expected by the SFDR as well as investors. Net0's reporting complies with all major regulatory frameworks worldwide, including the GHG Protocol, the SECR, the SEC Climate Disclosure, the CSRD, and more, ensuring credibility and reliability in carbon calculation and reporting efforts.

SFDR filings must be submitted by 30 June for the preceding year. All PAI indicators must be calculated at the end of every quarter and then averaged for the annual submission.

Schedule a demo with Net0 to discover how we can streamline your emissions data management for your SDFR report.

Written by:

Kristin Irish

As a content writer for Net0, Kristin harnesses her expertise and enthusiasm for carbon emissions reduction, merging it with her other passion: the B2B SaaS industry. Her global outlook and dedication enrich the sustainability sector with insightful perspectives.
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