The Sustainable Finance Disclosure Regulation (SFDR) is a regulation that mandates financial institutions within the EU to disclose sustainability-related information on their investment products. Adopted in 2019 and implemented from March 2021, it was introduced to prevent greenwashing of financial products such as funds.
Among the concepts first introduced by the SFDR, the most intuitive is the fund classification system. This classification system sorts funds into three categories based on how close they are to sustainable investment, and they are referred to as ‘Article 6,’ ‘Article 8,’ and ‘Article 9’ funds under the regulatory provisions.
Article 6 funds are conventional funds that do not treat ESG as a primary objective. Financial institutions need only disclose the potential impact that ESG risk factors may have on the fund’s investment returns. Article 8 funds aim to promote Environmental and Social characteristics, but sustainable investment itself is not their core objective. Financial institutions must specify how the fund promotes those characteristics. Article 9 funds are funds whose core objective is sustainable investment. At the pre-contractual disclosure stage, financial institutions must specify not only the sustainability objective but also the concrete methods by which that objective is achieved.
[Sustainable Finance Disclosure Regulation (SFDR) © ESG.ONL/ESG Today]
However, the article numbers merely indicate the level of disclosure obligations. Since actual investment performance and the achievement of ESG objectives are separate matters, it is difficult to conclusively judge a fund’s sustainability level based solely on the classification system.
An important purpose of the SFDR is the prevention of greenwashing. Since the SFDR Level 1 disclosure took effect on March 10, 2021, and Level 2 technical detailed rules were applied from January 1, 2023, the current SFDR prescribes 64 disclosure indicators, including 18 mandatory indicators for corporate, sovereign, and real estate investments. The disclosure indicators include specific quantitative items such as greenhouse gas emissions, biodiversity impact, water use, and hazardous waste generation.
Under SFDR rules, national financial regulatory authorities may sanction asset managers within financial institutions and impose penalties including fines if the information disclosed by the financial institution is found to be inadequate.
The SFDR requires financial institutions to disclose sustainability information in the market’s own language — that of disclosure, rather than through direct regulation. Through this information, investors can directly compare and judge which funds pursue sustainability and to what extent.
by Editor O