Kryptolesson #28

What is the EU Sustainable Finance Disclosure Regulation (SDFR)?

And how does it provide insights on how sustainable a financial product is? The EU Sustainable Finance Action Plan (SFAP) ↗ is a major policy objective which aims to promote sustainable investments across the 27 member states of the European Union. The SFAP is laid out in alignment with the world´s most significant sustainability-related agreements, such as the Paris Agreement of December 2015 ↗ and the UN-2030 Agenda for Sustainable Development ↗ earlier in 2015, whereof originated the Sustainable Development Goals. Furthermore, it is aligned with the goals of the European Green Deal ↗, which aims carbon-neutrality within the EU by 2050. The implementation of the SFAP started with parts of it (Level 1) becoming effective on 10th March. More complex laws (Level 2) have a longer lead time and are to be implemented on 1st January 2022.

A key component of the SFAP is the Sustainable Finance Disclosure Regulation (SFDR) ↗, a novel set of regulations and taxonomy that provides an EU-wide standard regarding financial products´ sustainability disclosure. The main goal of the SFDR is to provide a more comparable and comprehensive sustainability framework for evaluating funds. Through this measure, clarity, transparency, and truly sustainable investment alternatives are facilitated for the end investor. In alignment with ESG, the SDFR defines “sustainable investment” as follows: „…an investment in an economic activity that contributes to an environmental objective, as measured, for example, by key resource efficiency indicators on the use of energy, renewable energy, raw materials, water and land, on the production of waste, and greenhouse gas emissions, or on its impact on biodiversity and the circular economy, or an investment in an economic activity that contributes to a social objective, in particular an investment that contributes to tackling inequality or that fosters social cohesion, social integration and labour relations, or an investment in human capital or economically or socially disadvantaged communities, provided that such investments do not significantly harm any of those objectives and that the investee companies follow good governance practices, in particular with respect to sound management structures, employee relations, remuneration of staff and tax compliance”.

Pre-defined metrics assessing sustainability goals and risks for financial products in line with the above definition are to be implemented by financial product issuers. The most noticeable and impactful element is the classification of funds and mandates in three categories, as laid out by Articles 6, 8 and 9 of the SFDR. This information must be included in the fund prospectuses, on the website and Key Investor Information Documents (KIIDs). A responsible investor can use these categories for a fast, comprehensive overview on the aspiration for sustainable investment of a specific product.

These are:

Article 6 SDFR: Funds which do not integrate any kind of sustainability into the investment process. These could include stocks that are currently excluded by ESG funds, e.g. tobacco companies or thermal coal producers. These must be clearly labelled as non-sustainable.

Article 8 SDFR: Financial products that “…promote, among other characteristics, environmental or social characteristics, or a combination of those characteristics, provided that the companies in which the investments are made follow good governance practices…”. With kryptobest, we consequently pursue sustainable investment strategy in alignment with Article 8 SDFR.

Article 9 SDFR: These are products "..where a financial product has sustainable investment as its objective and an index has been designated as a reference benchmark". To qualify as an Article 9-conform product, information on how the index is aligned with the objective of sustainable investment is needed. Also, it requires a disclosure on why and how the index aligned with that objective differs from a broad market index. Whenever a fund has a reduction in carbon emissions as its objective, the additional disclosures shall also refer to the objective of low carbon emission exposure in view of achieving the long-term global warming objectives of the Paris Agreement.

Photo by Eriks Abzinovs