Sustainable Finance Disclosure Regulation
This article introduces one of the ESG regulations in Europe, the Sustainable Finance Disclosure Regulation (SFDR). The Sustainable Finance Disclosure Regulation officially came into effect in March 2021, aiming to improve the transparency of sustainable products in the financial industry and reduce greenwashing behavior in the financial sector.
The Sustainable Finance Disclosure Regulation specify the disclosure of sustainability related information on sustainable risks and financial products, as well as the potential adverse effects of product investments. The Sustainable Finance Disclosure Regulation is based on the framework created by the EU Taxonomy to identify essentially sustainable products and activities, which is very similar to the issuance of the Corporate Sustainability Reporting Directive (CSRD).
Related Post: Introduction to the European Sustainable Finance Disclosure Regulation SFDR
Basic Information about Sustainable Finance Disclosure Regulation
The Sustainable Finance Disclosure Regulation are established for financial market participants, such as investment companies, venture capital funds, pension funds, asset management companies, insurance companies, and investment advisors. All financial market participants located in the European Union, as well as non EU participants selling their products in the European region, fall within this scope. Financial market participants with more than 500 employees are required to disclose mandatory information, while others are required to disclose based on the principle of comply or explain.
Disclosure of financial market participants is divided into two levels, namely the company level and the product level. These disclosures include participants’ sustainable investment goals, how to integrate sustainability and ESG factors, and how to assess adverse sustainability impacts.
At the company level, financial market participants must disclose:
- Potential adverse effects of investment decisions on ESG factors.
- Whether these risks been considered in investment decisions.
- Whether the salary policy is consistent with sustainable development risks.
At the product level, financial market participants must disclose:
- How product performance is affected by sustainable risks.
- How does the product affect sustainability.
- Monitoring, measurement, and evaluation process of the sustainable impact of products.
Financial market participants are also required to disclose 14 principal adverse impacts (PAIs) and at least two additional principal adverse impacts, and issue a statement of PAIs. The 14 major adverse effects include:
- 1. Greenhouse gas emissions (Scope 1, Scope 2, and Scope 3).
- 2. Carbon footprint.
- 3. Greenhouse gas intensity of the invested company.
- 4. Investment exposure of companies in the fossil fuel industry.
- 5. Proportion of non renewable energy consumption and production.
- 6. Energy consumption intensity in high impact climate sectors.
- 7. Violation of the UN Global Compact Principles and OECD Guidelines for Multinational Enterprises.
- 8. Lack of monitoring processes and compliance mechanisms that comply with United Nations Global Compact Principles and the OECD Guidelines for Multinational Enterprises.
- 9. Unadjusted gender wage gap.
- 10. Gender diversity in the board of directors.
- 11. Investment exposure of controversial weapons.
- 12. Investee countries subject to social violations.
- 13. Investee countries subject to environmental violations.
- 14. Number of discrimination incidents.
How to Comply with Sustainable Finance Disclosure Regulation
Financial market participants must publish a due diligence policy for sustainable risks on their websites, which includes how to identify the major adverse effects related to the company, rank these PAIs, and take mitigation measures. Participants also need to explain how they prevent and manage conflicts of interest. The Sustainable Finance Disclosure Regulation do not impose penalties for non-compliance, but stakeholders can compare participants’ products based on these disclosures and create reputational risks for the company.
In order to fulfill their disclosure obligations, financial market participants may need invested companies to provide more detailed ESG information, which increases the workload of small and medium-sized companies. Some companies can also showcase their ESG practices through these disclosures, thereby gaining longer-term investment opportunities and green financing.
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