What is the SFDR and what are its main requirements for the financial market participants?

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With effect from 10th March 2021, Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability-related disclosures in the financial services sector (the ‘SFDR’) will start to apply. This write-up purports to provide the readers with a high-level summary of the main requirements that emanate from the SFDR which forms part of the EU’s package of measures relation to environmental, social and governance issues.

Although the SFDR imposes a number of disclosures which apply specifically to financial products which have a specific focus towards ESG and sustainable investments, it equally applies to all financial market participants even those which do not have an express focus on sustainability factors.

The Regulation includes in its scope entities which qualify as ‘financial market participants’ including inter alia (i) AIFMs (including self-managed AIFs which exceed the thresholds prescribed by the AIFMD and as such qualify as AIFMs in their own right); (ii) UCITS Managers (including self-managed UCITS); and (iii) MiFID firms providing the service of portfolio management. The SFDR disclosures also apply to ‘financial products’ made available by the financial market participants which term is defined to include: (i) AIFs; (ii) UCITS; and (iii) portfolio management services/managed accounts.

The SFDR requires financial market participants (the ‘FMPs’) to disclose specified information on their website, in the pre-contractual information for a financial product (in the offering documents of the financial product), and (in some cases) in the periodic information provided to investors. The exact level of the nature and format of the information to be disclosed remains to be finalised through the Level 2 RTSs.

In this part we will now focus on the three main substantiality-related disclosures which must be taken into consideration asap:

  1. Sustainability risk disclosure:

This applies at the FMP’s level depending on its approach to the integration of sustainability risk in the investment decision‐making process.

The FMP shall publish a statement as to whether and to what extent it integrates sustainability risks into its investment decision making process: this requires updating of due diligence and risk management policies (Article 3).

Moreover, every FMP must make a business decision to either: (a) implement a due diligence policy with respect to the principal adverse impacts of its investment decisions on sustainability factors, at the level of the manager as an entity (see Article 4(1)(a) of the SFDR) COMPLY or (b) explain the reasons why it does not consider such adverse impacts (see Article 4(1)(b) of the SFDR) EXPLAIN.

Every financial market participant must update its existing remuneration policy to include information on how the policy is consistent with the integration of sustainability risks (see Article 5).

  1. Disclosures applicable to all financial products

Pre-contractual disclosures: the FMP must determine in respect of each financial product whether to (a) assess the likely impacts of sustainability risks on the returns of each financial product COMPLY; or (b) EXPLAIN why it does not consider sustainability risks to be relevant to a particular financial product. Refer to Article 6(1).

Additional disclosures will apply by December 2022 whereby every FMP must assess whether and how each financial product considers principal adverse impacts on sustainability factors.

  1. Additional disclosures applicable only for financial products that have a specific sustainability-focus

Additional disclosures will be needed where a financial product: promotes environmental or social characteristics (Article 8); or (ii) has sustainable investment as its objective (Article 9)

For these specific financial products, the FMP must disclose certain prescribed information: (i) on how those characteristics are met; and (ii) on any index designated as a reference benchmark. The disclosures have to be included in the (a) FMP’s website, (b) in the offering documents, and (c) in periodic disclosures.

The MFSA has published a circular in which it has announced a fast-track filing procedure for the submission of updated offering documents in compliance with the SFDR (in addition to a Board resolution at the level of the FMP (in the case of externally managed financial products) and at the level of the financial product and a confirmation by the Compliance Officer of the Scheme).