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Greening the Financial Sector: New Sustainable Finance Regulations in the EU

Climate change is influencing the status quo of business activities worldwide. No actor can avoid this driving force towards net-zero, and the wave has finally reached the financial sector with new regulations in the European Union. The financial sector is key to unlocking the system-wide change that is needed to reach net-zero emissions. In this blog, one of Schneider's sustainability experts in the EMEA region summarizes the EU’s new Sustainable Finance Disclosure Regulation (SFDR) – a major step to increasing transparency and greening the financial sector.

Contributed by: Elena Cernov, Sustainability Consultant, Schneider Electric Energy & Sustainability Services

Elena assists clients on topics related to GHG emissions accounting and reporting, compliance with the European Energy Efficiency Directive (EED) requirements and other sustainability services. Focus areas of expertise include CDP, EED, SBT and other mandatory and voluntary carbon reporting and disclosure schemes in the EMEA region. Elena is also involved in the development of client sustainability strategies including analysis and benchmarking of performance to support organizational goal setting and implementation planning.

Understanding the sustainable finance trend

Sustainable finance is already on the upswing—on a global scale, Blackrock’s proclamation of sustainability as its new standard for investing signaled what many consider a point-of-no-return for the financial market. There are plenty of companies committed to significant emissions reductions and carbon neutrality, and we are seeing more governments increase their Paris Agreement commitments and integrate carbon targets in their strategies. Following this momentum, in December 2019 the European Commission presented the European Green Deal; a growth strategy aiming to make Europe the first climate-neutral continent. Parallel to developing the Green Deal, the European Commission (EC) has been working since 2018 on an action plan for a sustainable finance strategy to support economic growth while reducing pressures on the environment and taking social and governance issues into consideration.

In collaboration with various technical expert groups, the EC has developed mechanisms to facilitate the transition to a more sustainable financial system and to avoid greenwashing. The resulting set of legislative instruments complement each other and assure a sustainable transition:

  • Sustainable Finance Disclosure Regulation (SFDR)
  • Taxonomy Regulation
  • EU Climate Benchmarks and Benchmarks’ ESG (environmental, social, governance) Disclosure
  • EU Green Bond Standard

In this article, we will focus primarily on the SFDR and reference its connection to other legislative instruments for sustainable finance. Stay tuned for a follow-up of this blog, where we will explore other elements of the regulation.

Key facts to know about the SFDR:

  • It enters into force on March 10th, 2021

  • It’s a regulation… which within European Union means that it becomes immediately enforceable as law in all member states simultaneously and does not need to be transposed into national law (compared to EU directives). When a regulation comes into force, it overrides all national laws dealing with the same subject matter.

  • It’s about informed decision-making... the main goals of the SFDR are to support the transition of private investment to a climate-neutral economy, provide ground for informed investment decision-making and avoid greenwashing.

  • It affects various financial market participants directly... specifically:

Financial market participants in the EU: Insurers providing insurance-based investment products (IBIPs), pension product providers, banks/MiFID firms providing portfolio management, managers of other EU financial products, UCITS Management Companies, alternative investment fund managers (AIFMs), etc.  

Financial advisors in the EU: banks/MiFID firms providing investment advice, insurance intermediaries advising on IBIPs, insurers providing advice on IBIPs, UCITS Management Companies providing investment advice, AIFMs providing investment advice, etc. Financial advisors with less than 3 employees are exempt from the disclosure obligation.

Non-EU financial market participants: funds marketed into a European Economic Area (EEA) member state under the national private placement regime, or investment managers managing a segregated mandate for a client based in an EEA member state that interprets such management as taking place in that member state (other than by way of permitted reverse solicitation).

  • It affects many other companies indirectly... Portfolio companies or companies interested in attracting investments will have to get ready to provide ESG-related data to financial market participants for their disclosure. Investees will also be affected by a new invest-ability assessment: the SFDR and Taxonomy regulation outline criteria that investee companies will have to meet in order to qualify as sustainable investments.

What does the Sustainable Finance Disclosure Regulation do?

The SFDR sets requirements for financial market participants (FMPs) to start or continue disclosing information about the environmental and social impacts of their policies and financial products. There are requirements at both the company (management) level and at the financial product level.

Disclosures required at the company level include:

  • Policies on the integration of sustainability risks into investment activities (on website; mandatory; starting with March 10th, 2021)
  • Due diligence policies on the adverse impact of sustainability risks on investment decisions (on website; comply or explain, mandatory to companies with over 500 employees; by June 30th, 2021)
  • Remuneration policies – consistency with the integration of sustainability risks (on website; mandatory to all FMPs; by June 30th, 2022)

Disclosures required at the financial product level (starting in January 2022, to be reported by June 30th, 2022) include:

  • Disclosure on the integration of sustainability risk in the management of products (in pre-contractual agreements; mandatory)
  • Reporting on the adverse impact of sustainability risks on investment decisions (in pre-contractual agreements and periodic/annual reports; comply or explain, mandatory to companies with over 500 employees)
  • Additional reporting for “light green” and “dark green” products (in pre-contractual agreements, on website, in annual reports; mandatory): Light green products are products with environmental or social characteristics, among other characteristics (as defined by EU Taxonomy Regulation). Dark green products are products with a sustainable investment objective (as defined by EU Taxonomy Regulation)

What steps can organizations take to prepare?

The SFDR is in level 1 of its development, in which the framework principles are set out. The European Commission is expected to complement the regulation with Regulatory Technical Standards (level 2) and guidelines for implementation on rules (level 3). In the meantime, affected parties have to start disclosure based on the broad requirements detailed in the regulation.

We recommend financial market participants and financial advisors begin with these 4 steps:

  1. Assess whether the company is within the scope of the regulation
  2. Revise policies on sustainability risk assessments and remuneration
  3. Determine if the company has any financial products marketed as (light or dark) green products since that triggers additional disclosure requirements  
  4. Develop a compliance roadmap

Corporate ESG reporting will only grow in relevance as the pressure for investors to disclose the sustainability of their investments becomes more intense. Companies that integrate ESG factors into their core strategy and provide meaningful sustainability reporting will be the most attractive for investors – not only in the EU but in regions around the globe as well.

If you want to learn more about how to disclose sustainability impact and climate risks and understand your compliance needs and potential benefits, contact us today and talk to our dedicated team of experts.