SFDR: Sustainability-related disclosures

Since 2020, the Taxonomy Regulation has been one of the main pillars of the European Union’s regulatory framework in environmental matters. The European Taxonomy is a classification system.

Like any classification system, the definitions and rules of the Taxonomy determine which economic activities are environmentally sustainable.The Taxonomy has six environmental objectives:

• Climate change mitigation
• Climate change adaptation
• Sustainable use and protection of water and marine resources
• Transition to a circular economy
• Pollution prevention and control 
• Protection and restoration of biodiversity and ecosystems

The Taxonomy Regulation was created to combat greenwashing to enable financial market participants to identify and invest in sustainable assets with greater confidence.

The Taxonomy measures the ‘green’ share of a company’s activities or of a financial product (in particular, portfolio or investment funds). Its aim is to compare the contribution of different economic actors and financial products to the ecological transition in order to guide investment decisions.

The Taxonomy interacts with other key European regulations such as the SFDR Regulation, the CSRD Directive, or the ESG MiFID and IDD amendments. 

The Taxonomy has been thought of as a major tool for transforming the economy into sustainable development.

SFDR is a European regulation which establishes transparency obligations with regard to certain financial products or financial service linked to management on behalf of third party and their producers or managers.  

In practice, this means that financial market participants must disclose the impacts of their investment decisions on behalf of third-party on the environment and society and how they consider the financial risks caused by environmental, social or governance (ESG) events on the value of these investments. Financial advisers are also covered by this regulation.

The financial products directly affected by SFDR are funds and products similar to funds, including life insurance contracts, managed portfolios.

France already had a specific framework before the publication of SFDR with article 173-VI of the Energy Transition for Green Growth Law (LTECV), which required the publication of information on how to take ESG criteria into account in investment policy, in particular on climate risks. The Energy Climate Law replaces the existing French legal framework. It complements the European framework set up by SFDR by providing for additional reporting obligations at the entity level with regard to the inclusion of sustainability risks in investment policies, in particular for biodiversity issues.

In France, the entities concerned are:

• Credit institutions providing the portfolio management service
• Asset managers
• Insurers

SFDR requires two areas of transparency: 

• at financial products level (funds, insurance life products, portfolio management), in particular those that highlight ESG characteristics or have a sustainable investment objective and
• at financial market participant level, i.e. institutions which takes or recommends investment decisions on behalf of third parties within the framework of the financial products.

SFDR introduces new concepts such as:

• “sustainability risks”: mean an environmental, social or governance event or situation that, if occurring, could have a significant, real or potential negative impact on the value of the investment;
• "negative impacts on sustainability factors": mean the negative impacts on ESG aspects caused by investment decisions.Financial institutions are required to publish pre-contractual and periodic information on financial products with sustainable characteristics.

Each institution is also required to explain how its investment policy takes into account sustainability risk and major negative impacts on sustainability factors.

SFDR requires financial products to be classified according to their sustainability level:

• Financial products promoting environmental or social characteristics (called “Article 8 products”)
• Products with a sustainable investment objective (called “Article 9 products”)

SFDR is not a label for sustainable financial products but a level of transparency for investors. 

SFDR creates new transparency requirements on the "principal adverse impacts" of sustainability. The financial market participants have to: 

• publishing information about their policies on integrating sustainability risks into their investment decision-making process;
• provide information on the negative consequences of their investments on sustainability factors by publishing annually a declaration including a list of quantitative indicators. The latter are divided into two categories:
  - climate & environmental indicators
  - and social & personnel indicators
• Publish information on how remuneration policies are adapted to the integration of sustainability risks