The European Union has taken sustainability and climate change seriously for quite some time, having joined the net-zero movement and implementing financial disclosures like the NFRD and the CSRD, but the E.U. isn’t stopping there as they implement the Sustainable Finance Disclosure Regulation – otherwise known as the SFDR.
As shown with previous disclosures implemented in the European Union, the bloc has made it clear that they view redirecting capital flow as the most viable method to creating a more sustainable society. How does the SFDR help to improve the transparency and sustainability of businesses within the European Union?
What is the SFDR?
The SFDR is a disclosure regulation implemented by the European Union that strives to promote transparency and sustainability throughout the market to prevent allegations like greenwashing, and to ultimately aid the transition to a more energy efficient, sustainable, net-zero society. The SFDR demands a detailed disclosure regarding sustainability, and also requires multivarious ESG principles, otherwise known as environmental, social, and governance principles to be reported as well.
The SFDR was recently revised last March in order to allow for more detailed disclosures to yield to the European Union’s Sustainable Finance Agenda. The E.U. Sustainable Finance Agenda is a method for the European Commision to fund future environmentally friendly and sustainable economic activities in order to help the bloc reach carbon neutrality and improve sustainability by 2050. and the SFDR is a pivotal component of this as it will economically benefit businesses within the European Union while simultaneously reducing emissions.
What is the main goal of the SFDR?
Even though the European Union can implement several regulations to ensure all countries that are a part of the E.U. meet a minimum standard, discrepancies in both financial and sustainable efforts will continue to differ throughout the continent – and the main goal of the SFDR is to bridge the gap between any potential inconsistencies regarding disclosures.
The SFDR is dedicated to reducing several inconsistencies, such as sustainability risks, the impact of existing sustainable measures, how a company’s environmental or social characteristics are perpetuated to current or future customers or investors, and how investments are made in a sustainable manner. Those required to participate in the SFDR must disclose several of these activities to investors to prevent future predicaments or public allegations, and ultimately contribute to a more sustainable future for the European Union.
Why is the SFDR key to the future of sustainability in Europe?
The SFDR is a key component to the future of sustainability through the European Union, as the SFDR is designated to propel capital activity towards sustainable endeavors and ultimately, encourages investors and clients to choose companies that support a more sustainable future. In short, the SFDR acts as an incentive for those who cannot find the intrinsic motivation necessary to build or contribute towards a more sustainable economy. The SFDR does this by requiring companies to report upon their transparency regarding their environmental and social impacts.
Improving transparency is essential to improve upon sustainable measures throughout the European Union, as disclosure regulations like the SFDR make it increasingly difficult for companies to greenwash their customers. Basically, the SFDR ensures that any environmental claims regarding a product or service offered throughout the E.U. are valid.
Not only will the SFDR help prevent these potentially detrimental discrepancies, but the SFDR will provide investors with more detailed information that can help them decide if it is truly the right investment for them. Many stakeholders are growing more interested in the environmental impact of their investments, and therefore – the sustainable finance disclosure regulation can help ensure the stakeholder that their potential investment pertains to their own individual environmental goals and values.
What is required for those who must adhere to the SFDR?
Those who are required to report under the Sustainable Finance Disclosure Regulation must organize their ESG funds and various products into three different “articles”, or categories markeda as article 6, article 8, or article 9.
All asset managers are required to report to the SFDR, even for companies that do not promote environmentally friendly products or services – although, the products or services that claim to pertain to ESG values will demand a more in-depth report in accordance with the SFDR.
Items that fall under article 6 refer to funds or investment that do implement sustainability into a company’s investment process. These investments could be stocks garnered towards the production of tobacco, coal, or other toxic substances that harm the environment. Under the SFDR, it is compulsory that asset managers mark these funds as non-sustainable.
The funds that do pertain to sustainability fall under either article 8 or article 9, but the two slightly differ from one another. Article 8 funds refer to products that encourage positive environmental or social activity, whereas Article 9 are products or investments that have a clear sustainable goal. Both articles either do little damage to the environment, or benefit sustainability – unlike funds that fall under article 6, which aren’t sustainable at all.
The SFDR requires that asset managers disclose ESG information for all funds, with the level of detail in disclosure increasing up to Article 9.
However, since there are already so many different types of financial and sustainability directives and disclosures in the European Union’s Sustainable Finance Agenda – what makes the Sustainable Finance Disclosure Regulation different from the other regulations currently in place?
How is the SFDR different from the NFRD or the CSRD?
Given several other compulsory financial disclosures exist throughout the European Union, such as the Non-Financial Reporting Directive and the Corporate Sustainability Reporting Directive – what makes the Sustainable Finance Disclosure Regulation different from the NFRD or the CSRD?
The NFRD is another financial reporting directive where companies that employ more than five hundred people, possess twenty million euros in assets, or have a net turnover of over forty million euros annually must comply with. On the other hand, the CSRD is a more comprehensive reporting directive than the NFRD – as any large company employing more than two hundred and fifty people, which also meets two of these three previously mentioned standards, must adhere to. In short, the CSRD is more stringent than the NFRD and more companies in E.U. are subject to the corporate sustainability reporting directive.
Those required to report to the NFRD must provide extensive reports on the company’s environmental activities such as their rate of carbon emissions, efforts to maintain equality amongst the workplace, their anti-corruption measures, and how well they promote diversity.
More companies throughout the European Union must adhere to the CSRD, as it is newer than the NFRD requires additional reporting – such as demonstrating their sustainability and climate change risks, as well as a more detailed illustration of their contributions to both the environment and society.
Ultimately, what makes the SFRD different from both the NFRD or the CSRD is that the Sustainable Finance Disclosure Regulation pertains to future investors more than it does for companies. The NFRD and CSRD seek to improve the environmental and social measures within companies, whereas the SFDR strives to aid investors choose the most sustainable investments possible – and mitigate future investments in unsustainable projects.
What are the pros and cons of the SFDR?
The benefits of the Sustainable Finance Disclosure Regulation are clear. The SFDR pivots capital flow towards businesses and projects that are dedicated to sustainability, and mitigates investors from financially contributing to organizations that don’t pertain to the measurements necessary to reduce emissions or reduce climate change.
However, it doesn’t mean that the SFDR doesn’t have room for improvement. The SFDR is relatively user friendly, with the three categories or “articles” making it simple for investors and businesses to understand. On the contrary, these categories are too general and can often be difficult to delineate all the negative or positive impacts of each activity, product, or service. Even worse, the lack of clarity between the categories can lead to confusion and miscalculations.
While these labels are said to be under review to improve the future efficiency of the SFDR – it could be a while until they are, meaning it would be up to investors and businesses to scope out potential greenwashing by themselves.
This is something the Sustainable Finance Disclosure should aim to refine and take full responsibility for, as investors and businesses alike are not likely to easily decipher the difference between greenwashing and true sustainable efforts.
The good news is that despite the need for improvement for the categories in the Sustainable Finance Disclosure Regulation, the SFDR has already seen improvements in sustainability amongst the E.U. market – even after only being intact for one year.
Does the SFDR improve sustainability in the E.U.?
So, has the Sustainable Finance Disclosure Regulation been successful for the European Union in improving sustainability?
The SFDR has indeed had a positive impact on the economy in the E.U. so far – allocating nearly two thirds from products that promote positive environmental and social ideals in addition to products that pertain to sustainable investments. Ultimately, the SFDR has encouraged businesses throughout the bloc to implement sustainable development in order to maintain their relevance. In fact, over half of the new funds that started in the bloc during the last quarter of 2021 adhered to the sustainable demands delineated in the SFDR.
The SFDR is ultimately a clear and concise step towards sustainable development throughout the E.U., and utilizing other existing measures like ESG investing in order to work towards a more sustainable economy and brighter environmental future. Ultimately, the Sustainable Finance Disclosure Regulation will benefit investors in the future as it delineates several potential environmental and social discrepancies to be disclosed – meaning at the end of the day, only the businesses most worthy of continued financial support will get it. Companies that don’t adhere to regulations like the SFDR will lose the interest of both customers and investors, and be faced with the choice of becoming obsolete or making real change.
It’s more than likely that the SFDR, alongside the other disclosure in the E.U. Sustainable Finance Agenda, will continue to create more sustainable businesses and ultimately – a more sustainable economy throughout the European Union. Passion is good for getting started, but could prove ineffective to keep the momentum of the initial sustainable goals in sight. Regulations like the SFDR will give everyone a nudge who has forgotten the importance of sustainability.
What about Greenly?
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