SFDR so far: will funds deliver on the promises of 2021?

Green building

Just over one year on from when the EU's Sustainable Finance Disclosure Regulation (SFDR) took effect, where are funds at in their compliance and have the new disclosure laws had any impact on greenwashing?

With COVID-19 legislation and restrictions finally easing across the EU, the continent looks to be emerging from the winter of its discontent into a more hopeful spring. The virus, which has taken up so much of our focus, time and money over the last two years, is beginning to drop down the priority list. Resurfacing in its place are those broader issues that remain wilfully evergreen: environmental, social and governance (ESG) issues.

Last month marked one year since SFDR came into force, and market participants who may have managed to fly under the radar thanks to a global preoccupation with the pandemic are finding themselves under the ESG spotlight. Regulators and investors are asking the same question: are funds doing enough?

Sustainability promises have been made, as per SFDR’s Level 1 requirements, and we have certainly observed a shift in ambitions among asset managers. But whether meaningful change has ensued, and greenwashing reduced, is far from clear. The making of promises does not necessarily equate to the keeping of them.

There has also been significant confusion surrounding the classification of ESG funds and other investment products. While the point of this mandated classification into Articles 6, 8 and 9 – each indicating a different tier of sustainability – was to better enable investors to compare and invest in products that align with their own priorities, a lack of clear definitions has allowed for a wide range of interpretations by asset managers. In many cases, this has led to further confusion among investors.

Such teething issues are unsurprising in the biggest regulatory shift the funds industry has ever seen within the sustainable investment space. But they are important to address as countries around the world begin to follow suit.

The next level of SFDR requirements – the Regulatory Technical Standards (RTS), formally coming into effect on 1 January 2023 – will provide a format for the requirement of firms to make periodic and ongoing disclosures on how they have performed against their sustainability promises. As this gets underway, fund managers and investors may take some comfort in knowing that the hardest part is now. As more disclosures are made, and countries around the world collaborate to develop more consistent yardsticks, greater standardisation and clarity will be possible. For the moment, firms must put their heads down and seek clarity at every turn.

Central to this will be data accessibility. As it stands, the lack of information sharing between funds and portfolio companies – on which funds must report – is making data collection and goal tracking difficult. As portfolio companies do not face the same regulatory consequences, they are not equally motivated to comply.

The best path forward is to start the aggregation process as soon as possible. One more efficient method for this may be to recruit the services of a third party to connect a group of portfolio companies, and work with them independently to generate information, package it, and return it to the fund to feed into disclosure reports.

For funds who are still unclear what applies to them and when, now is the time to consult an expert. Experienced professionals can serve as useful intermediaries to help draft and collect the right disclosure data, and establish achievable ESG targets, leveraging a broader knowledge base of the increasingly expansive ESG landscape than individual funds could ever be expected to accrue. Those who leave it to the last minute could take a hit to both their reputation and their bottom line.

This article was originally published by Private Equity News.