While sustainable investing isn’t a new idea — the first sustainable investment fund, Pax World, launched in 1971 — it has exploded in popularity over the past few years.
Investors are rebalancing their portfolios to make them more sustainable in record numbers.
But if sustainable investments are better for the planet and more resilient — in 2020, they outperformed traditional investments by an average of 0.9% — their popularity has also turned ‘sustainability’ into somewhat of a buzzword.
As a result, legislators have stepped in to make sure that, when asset managers and other financial market players bill themselves and their products as sustainable, they really mean it. And the biggest legislative initiative to ensue — the EU’s Sustainable Finance Disclosure Regulation, or SFDR — is radical, far-reaching, and has complex reporting obligations.
With the SFDR already partly in force, if you’re an asset manager you need to start ensuring you’re compliant, well, yesterday.
Here’s what you need to know about the SFDR, plus a simple trick to make meeting your reporting obligations as effortless as it can possibly be.
What is the SFDR?
The SFDR obliges asset managers to give prospective and current clients specific information about their approach to sustainability. In particular, you have to tell them:
- Whether an investment is bad for the environment or has negative social impacts, for example because it could lead to human rights abuses or encourage bribery, corruption, or other criminal activities
- How these issues will affect the investment. Does negative environmental impact risk making it less valuable in the long term, for instance?
- How you as a firm take sustainability into account when making business and investment decisions, including whether your decisions increase the risk of negative impacts
- If you haven’t taken possible negative impacts into consideration when making a business or investment decision, the reasons why not
The main aim of these requirements is to prevent greenwashing — exaggerated or misleading claims about environmental credentials — by forcing firms to be more transparent. As an EU Commission spokesperson put it: ‘any sustainability-related claim by a financial product must be well justified…‘
In other words, these disclosures should make it easier for investors to accurately gauge how serious you are about sustainability, and how sustainable the investment products you offer actually are.
What’s the SFDR’s implementation timeline?
The SFDR has two levels:
- Level 1 requirements came into force on 10 March 2021
- Level 2 requirements are set to come into force on 1 January 2022
So what’s the difference between level 1 and level 2 requirements?
Under level 1, you need to publish information about your sustainability policies on your website. In particular, you have to set out:
- How you assess possible negative impacts in key risk areas like climate, the environment, society, and corporate governance
- What actions you take when you identify negative impacts
- How you involve shareholders and other stakeholders in your decision-making process, including how sustainability informs your remuneration policy
- Your adherence to responsible business codes of conduct and international standards, including whether your activities are in line with the Paris climate agreement
You also need to publish assessments of sustainability risks in your pre-contractual information. And if you promote a product specifically because it’s sustainable, for example because one of its objectives is to reduce carbon emissions, you need to:
- Describe the objectives and specific characteristics that make it a sustainable investment
- Explain how you’ve assessed these characteristics and how you’ll monitor and measure its actual impact
- Explain how the product meets ESG principles
- If there’s a benchmark index, explain how this is consistent with ESG criteria
Level 2 sets out periodic disclosure requirements and fleshes out in greater detail:
- The methodology you have to use when assessing sustainability
- What specific information your disclosures should include
- Crucially, the format in which you must present the disclosures
The EU’s three supervisory authorities, ESMA, EIOPA, and the EBA, published these technical standards in February 2021. That said, they’re still in draft format, which means there’s some uncertainty around what the requirements will actually look like.
To add more complexity, because the SFDR came into effect after the Brexit transition period ended, it’s still unclear whether the UK will adopt it.
The UK Chancellor has hinted that, while the UK will adopt standards, they might diverge from those set by the EU and implemented on a different timescale. So, if you’re a UK asset manager that also operates in the EU, you might need to comply with two different regimes.
SFDR non-compliance: what are the risks?
According to an Independent Investment Management Initiative survey, 61% of asset managers think the SFDR is a positive development. But while greater transparency is always a step in the right direction, it comes with a number of significant risks.
The most obvious one is the hard implementation deadline.
With phase one already in force and phase 2 looking like it will definitely come into force on 1 January 2022 — though it has already been delayed once, so you never know — there’s enormous time-pressure to get ready.
The danger is that this will create reliance on stop-gap solutions such as email, Excel, and Word. Leaving aside how burdensome these processes are to manage, their inherently manual nature makes them unsustainable long-term. As one large asset manager put it to us:
‘We estimated that reviewing 15 stocks within a fund of 43 took one colleague between 1 and 1.5 days. It simply wouldn’t be viable with a portfolio of 100 companies.’
Another risk is innovating too slowly.
Sustainable investment is a fast-growing market. But the opportunities are greatest for those who seize it first.
Becoming a market-leader entails building a ‘digital supply chain’ with third party providers to create differentiated outcomes. And this simply isn’t possible unless you have systems in place that allow you to communicate and collaborate at speed.
The devil is in the data
The biggest challenge firms face is the sheer amount and complexity of data required for SFDR reporting.
When the Apex Group ran a poll, it found that only 30% currently track sustainability metrics. This means that, for a majority of asset managers, complying with SFDR will entail figuring out what data is required and where to get it from, finding and collecting it from those new sources, and mapping everything into a single model you can then use for aggregation, calculations, and comparisons.
And that’s only the start.
More significantly, you need to:
- Draw inferences from that data
- Create commentaries and explanations (probably in several different languages)
- Determine which negative sustainability impacts to prioritise
- Check your data quality, and send it off downstream
Making sustainability sustainable, with Fundipedia
If the importance of innovating quickly and the huge amounts of new data required for SFDR compliance mean manual processes won’t cut it, the flip side is that developing and implementing your own technology to handle the requirements can be extremely costly as explained in details in our article “buy VS build”.
And, because of the hard deadline, time is quickly running out.
The good news is that you don’t have to make a binary choice between inadequate, quick-fix solutions or a lengthy, expensive process that might not be ready by the deadline. At Fundipedia, we’ve created a module that’s designed specifically to collect, organise, verify, and disseminate all kinds of data, including data related to sustainability reporting.
Our platform comes with robust data sets built-in, so you can use it right out of the box.
But you can easily add new sources as you go, too. The system is designed so you can effortlessly run data experiments, even with large data sets. This means you can quickly find out what works best for your firm and build a bank of data points and insights as the area evolves.
Our sustainability module also populates the data into the format you require and updates automatically to incorporate rule changes. Which means that, once level 2 requirements kick in in January 2022, you’ll be good and ready to comply with them without having had to spend endless time and resources putting frameworks in place and training staff.
The future of investments is ethical and sustainable. Are you ready for it?
Bloomberg reckons sustainable investments will make up 33% of the world’s total assets under management by 2025. And this further growth can only mean one thing. The SFDR is just the first step on the journey towards a radical transformation in the way regulators and investors expect asset managers to make business and investment decisions.
Moving forward, it’s likely you’ll have to become even more open and transparent about your commitment to sustainability. With Fundipedia, you can focus on the substance — finding investments that truly make a difference — without having to second-guess the quality of your data or the format your disclosures must take.
Learn how Fundipedia can help you conquer SFDR reporting requirements with just a few clicks.
Book a demo today