Climate Risk - Sustainable Finance Disclosure Regulation (‘SFDR’)
by Rory Brazil on 28·09·2022
The SFDR applies to all Financial Planners from the 10 March 2022 who are:
- Insurance Brokers who provide insurance advice with regard to IBIPs.
- Investment Brokers who provide investment advice (through providers) to both retail and professional investors.
The rules apply to all financial products, including IBIPs, portfolio management, pension products and pan-European Personal Pension Products (‘PEPPs’), regardless of whether they are designed as “green” products with an ESG profile.
Financial Planners who provide advice on IBIPs, and investment firms that provide investment advice, are required to consider and factor in sustainability risks in their advice process, and to provide information in accordance with the SFDR, both at entity level (on their website) and at product level (at pre-contractual stage).
The SFDR introduces additional disclosure obligations for manufacturers of financial products and financial planners toward end-investors. The SFDR requires impacted firms to integrate sustainability into their investment processes and to consider the adverse impacts of their investments on sustainability factors. The SFDR applies regardless of whether the client has indicated an ESG preference or not.
Financial Planners can decide whether or not to consider principal adverse impacts on sustainability factors in their investment advice. However, if they decide not to consider the adverse impacts, they must prepare a disclosure outlining they are not considering the adverse impacts, and information on whether and when they intend to consider such impacts in the future. Principle Adverse Impact (‘PAI’) indicators are at the core of the SFDR and are key to understanding its objectives. They are measured at the financial product level by Financial Market Participants (‘FMPs’) and includes 14 mandatory indicators applicable to investments in investee companies, 2 mandatory indicators applicable to investments in sovereigns and supranationals and a further 2 mandatory indicators applicable to investments in real estate assets.
Under the guidance, Financial Planners should, at a minimum, consider these mandatory indicators when selecting financial products they advise on and this is explained further below in the “upcoming changes – SFDR Level 2” section. SFDR also sets out a number of optional indicators for investment products under the categories of “climate and other environment-related indicators” and “social and employee, respect for human rights, anti-corruption and anti-bribery matters”. The Regulatory Technical Standards (‘RTS’) notes that FMPs should add information on one or more additional indicators from each of the two categories noted above. Financial Planners may decide to consider these in their advice and disclose how products are ranked and selected based on both the mandatory and optional indicators.
Upcoming Changes – SFDR Level 2
The European Supervisory Authorities (‘ESAs’) published level 2 requirements during 2021, which set out specifications for the content, methodology, and presentation of required disclosures. The European Commission has confirmed a six-month delay to the application date of SFDR Level 2 requirements from July 2022 until the 1st of January 2023.
Classification of Investment Products
Of significant relevance to Financial Planners is how SFDR sets out a framework for classifying funds with respect to sustainability. By understanding these classifications, it will make it easier to assess the ESG criteria of funds which Financial Planners are choosing from. FMPs must identify if their funds:
- Promote environmental and / or social characteristics (Article 8); or
- Have a sustainable investment objective (Article 9)
- Funds which do not fall into either of these categories are, by default, classified under Article 6, which means they do not claim any particular sustainability or ESG characteristics.
If you would like to learn more, please get in touch. Email: rory.brazil@thetimebank.ie