EU Sustainable Finance Disclosures Regulations (SFDR) came into effect on the 10th of March 2021. The SFDR require financial market participants (FMPs) to provide common ongoing disclosures to investors, implementing rules on: i) how financial products incorporate environmental risks and inform end-investors, ii) how the impact of investments on the environment and society should be disclosed, and iii) how financial products that are marketed as sustainability-related meet that ambition.
These rules represent the foundations of the EU’s Sustainable Development Agenda, Carbon Neutrality Agenda, and its commitment to the Paris agreement, and significantly increase the onus on the financial sector to play its part in the fight against climate change. Central to the EU objectives are changing behavioral patterns in the financial sector, by discouraging green-washing and promoting responsible and sustainable investments. The intention is that enhanced transparency will drive change through increased awareness of financial products’ sustainability credentials.
It is widely recognised that the legislation is ambitious, not only in its content but in the timeline outlined for implementation. This ambition reflects political appetite for action and the recognition that the environmental crisis facing governments around the world is critical, and we are running out of time.
Increased emissions of greenhouse gases (GHG) have caused temperatures to rise, the results of which are becoming more evident every year. In 2020 alone we saw devastating bush-fires in Australia, a heatwave in Antarctica that saw temperatures rise above 20 degrees for the first time, the Greenland ice sheet melting at an unprecedented rate, China experiencing its worst floods in decades, Canada’s last intact ice shelf collapsing, a national park in the US recording the highest temperature ever recorded on earth, 13% of deaths in the EU being linked to various forms of pollution, and record-breaking wildfires in California that have blocked out the sun– and these are just a fraction of the events (earth.org).
The Paris agreement’s 2030 targets include a 40% cut in GHG emissions, for which the Commission estimates an investment gap of about 180 billion EUR per year.
Certain investment management organisations have for some time prioritised the integration of sustainable objectives into their product portfolio, leading the way in driving change through the promotion of sustainable investment options to investors. It is however widely acknowledged that the SFDR represent a step change for the sector, not least regarding the reporting requirements relating to environmental sustainability.
From January 2021, compliance with the Taxonomy Regulations (the legislation defining sustainable economic activities) will require the ongoing reporting of Principle Adverse Impacts indicators (PAIs). Draft Regulatory Technical Requirements (RTS) published in February 2021 include a mandatory reporting template for the PAIs, including a set of indicators for both climate and environment-related adverse impacts.
Mandatory reporting requirements inevitably result in organisations having to manage what is commonly referred to as compliance burden.
The term ‘compliance burden’ refers to the specific processes, budgets, and manpower the organization adopts to meet their regulatory obligations. For legislation of the scale set out in SFDR the burden should not be underestimated. A recent S&P Global survey regarding the challenges of implementing SFDR compliance rated data availability and data quality as second and third (first was lack of clarity on specific requirements).
One of the primary objectives of SFDR is the standardisation of environmental data and performance indicators allowing transparent comparability for end investors. Not surprisingly there is a concern is that the ‘compliance burden’ could be considerable, and indeed for some smaller organisations, prohibitive.
There is a risk that managing the process of compliance will become the priority when allocating valuable resources, overshadowing the critical objective of the SFDR, to reduce GHGs. Anyone reading this article who has worked in sectors where such comprehensive regulatory compliance requirements were introduced, will understand exactly what I am saying!
Investment in technology solutions such as automated data collection on energy, water and waste usage, analytical tools and Artificial Intelligence will be imperative to preventing compliance consuming valuable human resources and skills that should be working on the analysis and interpretation of the data, enabling the innovation required to really make a change.
FMPs are in a position to lead the way on environmental sustainability, and not let compliance overshadow the need for change.
For advice on Sustainability planning, compliance and reporting email firstname.lastname@example.org