When a company commits to operating in a more sustainable manner, that’s only the first step. Next comes the hard part: implementing the plan, and following through on the commitment. But how can you be sure a company is as committed as it claims to be? In the European Union, the answer is to require financial companies to disclose their sustainability practices through the new Sustainable Finance Disclosure Regulation (SFDR).
The regulation went into effect on March 10. It represents a major milestone in the EU’s effort to ensure financial firms are as transparent as possible when it comes to sustainability.
As International Banker reported in April, the SFDR falls under the EU/United Nations 2030 Agenda for Sustainable Development, which aims to move about 1 trillion euros into green investments over the next decade. The SFDR will address “the lack of consistency in the climate-related information that’s currently being provided by financial-market participants, and provide a competitive edge to those firms offering genuinely sustainable products.”
The regulation imposes more stringent requirements on disclosures made by banks, insurance companies, pension funds, investment firms, and other financial services companies. Two key areas of focus are sustainability risks and adverse impacts on sustainability through investment decisions and financial advice.
In a February article, Bloomberg Professional Services noted that the SFDR is part of a broader package of legislative tools that aim to move more capital into sustainable businesses. One goal is to ensure that financial market participants, or FMPs, can fund long-term growth in a sustainable manner. FMPs include the following types of businesses:
- Asset managers and other investment firms that offer portfolio management services
- Pension providers
- Insurance-based investors
- Qualifying venture capital and social entrepreneurship entities.
Financial products that will fall under the purview of the SFDR include investment and mutual funds, insurance-based investment products, private and occupational pensions, and insurance and investment advice.
Under the SFDR rules, if any of the above entities or products make sustainable investments, then managers should disclose how the investments comply with the “do no significant harm” principle established in the regulations.
The SFDR defines and introduces transparency requirements so they can be compared on the basis of their degree of sustainability. According to a blog on the BNP Paribas Asset Management website, they include the following:
- Consideration of sustainability risks, including the risk of depreciation in the value of underlying assets due to environmental or social events
- Sustainable investments in economic activities that contribute to environmental or social objectives, including investments in EU-taxonomy eligible economic activities
- Consideration of principal adverse impacts on sustainability factors. These are described as “the negative effects on environmental, social and employee matters as well as respect for human rights, anti-corruption and anti-bribery resulting from an investment decision.”
Another goal of the SFDR is to prevent so-called “greenwashing,” a term used to describe environmental claims that are either misleading or untrue. Greenwashing has been the focus of increased attention as more corporations and asset managers unveil ambitious Environmental, Social, and Corporate Governance (ESG) programs.
As CNBC noted in April, new investments in sustainable funds more than doubled in 2020 compared to the previous year, reaching a record-high $51 billion, according to data from investment research firm Morningstar. But it can be difficult to determine just how sustainable some funds really are.
Karen Wallace, Morningstar’s director of investor education, told CNBC that some funds are simply more sustainable than others. In the U.S., where there is no central authority requiring disclosures similar to those required by the SFDR, it’s important that investors find investments that align with their values.
Investors should also read the prospectus of ESG funds they’re interested in to learn more about the fund’s objective and the companies it invests in, Wallace added.