The European Commission’s Sustainable Finance Disclosure Regulation (SFDR) came into effect on 10 March 2021 and is set to trigger a host of changes in the financial sector.
So, how will the new disclosure rules change investing in the EU and other countries?
SFDR in a nutshell
SFDR is just one of many legislative tools designed to reorient Europe’s capital towards sustainable investments. It has two main objectives:
- make it easier for clients to identify and invest their money into ESG-friendly products.
- make it harder for financial firms and advisors to engage in greenwashing, whereby patchy and misleading information is provided, making products seem more sustainable than they actually are.
It achieves these objectives by imposing new disclosure requirements around sustainability in investments and applies to both financial entities and products, including:
- asset managers and financial advisers
- portfolio management services
- pension providers
- mutual funds
- insurance-based investment products
What are the SFDR disclosure requirements?
SFDR obligations apply to both firms and products and require asset managers to:
- disclose (in pre-contractual information) how sustainability risks factor in their decision making;
- provide an assessment of the principal adverse impacts (PAIs) their investments have on the environment or society – or explain why they have failed to do so;
- explain how ESG branded products plan to fulfill sustainability promises on their website and through their marketing communications.
What this means for asset managers
These measures will cause a tectonic shift in the way asset managers advertise and advise on sustainable investments, not just in Europe but potentially the world over.
SFDR affects all asset managers that raise money in Europe, regardless of where they are based. This means the new regulations have implications even for those funds offered to investors outside the EU.
Many firms in the U.S. also offer funds in Europe, and many will want to distinguish themselves by mirroring the additional disclosures around ESG investing. Furthermore, starting next month, Morningstar will collect information on self-identifying “green funds” to provide to users. This will enable American investors to look up Morningstar data on the European counterpart of their fund and see how well its ESG metrics are performing.
In Europe, it is estimated that €7.6 trillion ($11.7 trillion AUD) will be invested in ESG products by 2025, bumping the market share of European ESG assets from 15% to 57% overall. In the U.S.-domiciled sustainable investments totalled $17.1 trillion ($22 trillion AUD) at the beginning of 2020, up 42% from two years earlier. With statistics like these, asset managers face increasing global pressure to pivot their interests towards sustainable products.
What does SFDR mean for investors?
SFDR implementation in the EU is just one of the ways investor attitudes are shaping the financial landscape.
Socially responsible investing has been steadily growing for years. Morgan Stanley found that more than 85% of investors (and 95% of millennial investors) surveyed in a report were interested in sustainable investing. As investors, millennials are more likely than any other generation to select assets that align with their personal values; 77% cite owning impact investments and 88% regularly review the ESG impact of their holdings.
The new disclosure requirements increase transparency and provide a means to standardise what constitutes an ESG-friendly product. This has two important flow-on effects for investors; first, it deters greenwashing as asset managers can no longer slap an ESG logo on a product without having the evidence to back it up. Second, disclosure information will be easily accessible in the public domain, empowering clients to make informed decisions on investments that align with their values and goals.
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