How should I ensure I'm ready for the next reporting period under SFDR?

If you're an investor and want to ensure you're ready for the following Sustainable Finance Disclosure Regulation (SFDR) reporting period, you're in the right place. SFDR is a game-changer in sustainable investing, transforming the landscape, and being prepared is crucial to meeting regulatory requirements and making informed investment decisions for the next reporting period. This easy-to-read guide takes you through all the steps necessary to ensure compliance and make informed investment decisions.

SFDR is a European Union regulation that requires financial market participants, including investors and financial advisors, to integrate environmental, social, and governance (ESG) factors into their investment processes and disclose how they do so.‍

1. Determine Your SFDR Classification

First, you would need to understand which SFDR classification applies to your investment activities:

Article 6 (grey) funds: Classifying a fund as Article 6 comes along with the smallest disclosure requirements. Funds in this category are free to choose if they deem sustainability risks to be relevant for their investment decisions. If they do consider sustainability risks, they are required to explain how sustainability risks are integrated into their investment decisions and disclose how the sustainability risks affect their financial performance. If they do not consider sustainability risks, they are required to explain why they don’t integrate these into their investment decisions.  

Due to the low sustainability reporting requirements, an “Article 6 product” has often been described as a fund that does not integrate sustainability into the investment process. While this is probably an exaggeration for many funds, we see that many investors move towards Article 8 or 9 to reflect their sustainable intentions more clearly and to assure they can attract sufficient investments in the future.  

Article 8 (light or medium green) funds: Article 8 funds promote environmental and/or social characteristics. Funds in this classification shall collect quantitative and qualitative data on the environmental and/or social characteristics of their portfolio companies. Funds falling under the definition of Article 8 products shall apply ESG strategies to select their investments, but do not have to commit to any sustainable objectives. Responsible investment approaches, such as investment screening for ESG integration can be applied by investors.

Some practitioners differentiate between “light green” Article 8 and “medium green” Article 8+ funds. “Light green” article 8 funds advertise some environmental and social characteristics, but their investments explicitly do not contribute to any sustainable development objective. “Medium green” Article 8+ funds promote environmental and/or social characteristics and parts of their investments target a sustainable investment objective.  

Article 9 (dark green) funds: Article 9 funds have a sustainable investment objective for 100% of their investments. Investments can be made in economic activities with environmental and social goals, 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.  

The current momentum around sustainable development suggests that article 9 funds will become more and more attractive. They obtain more regulatory support; investee companies are less likely to face material ESG risks and many LPs favor investments with a clear positive impact. Classifying as an article 9 fund today represents an important differentiation and puts investments on a future-proof path. Therefore, we see that particularly many new funds aim for article 9. ‍

2. Assess ESG Integration Practices‍

Evaluate how ESG factors are currently integrated into your investment decision-making process. Document your ESG policies, procedures, and methodologies and identify any gaps or areas for improvement in your ESG integration practices, depending on your level of ambition about your classification.

Remember that SFDR requires you, as an investor, to disclose how you integrate ESG factors into your investment processes. Enhanced transparency can improve your confidence and contribute to better market performance.

We know that integrating ESG factors into investment decision-making processes requires careful consideration and expertise. You may need help assessing the materiality of ESG issues or incorporating them into traditional financial analysis. But by continuously evaluating and improving ESG integration practices and identifying gaps or areas for improvement, you can identify ESG considerations in investment decision-making frameworks and collaborate with industry peers to share best practices.   ‍

3. Identify ESG Risks and Impacts‍

Conduct a comprehensive assessment of your investments' environmental and social risks and impacts. Consider factors such as climate change, human rights, labour standards, and corporate governance.

Also, by integrating ESG considerations, investors may better identify and manage risks associated with environmental and social issues, potentially anticipating risk and enhancing long-term performance.

When it comes to market opportunities, investing in companies with firm ESG profiles may offer access to emerging opportunities, innovation, and resilience. Companies that effectively manage ESG risks and opportunities may outperform their peers over the long term, leading to superior investment returns. We recommend looking at various ESG rating agencies, such as MSCI, Sustainalytics, and LSEG, which provide comprehensive ESG data and analysis on companies and investment funds. Investors can leverage these platforms to evaluate the ESG performance of their investment portfolios and assess the potential impact on returns.‍

4. Review SFDR Disclosure Requirements

Familiarize yourself with the specific disclosure requirements for your SFDR classification and understand pre-contractual (website, prospectus) and periodic (annual) disclosure obligations.

At ImpactNexus, our software allows you to create and export a pre-contractual and a periodic SFDR report for your funds. Investors can use this report to gather sustainability-related information on the fund before they invest. ‍

5. Collect ESG Data with Data Management Systems‍

Now, it’s time to collect relevant ESG data from your portfolio companies. If you haven't already, we highly recommend investing in a robust data management system to collect, analyse, and communicate ESG data, effectively. At ImpactNexus, we constantly ensure you have updated solutions on hand to do this right. Also, consider leveraging technology solutions for streamlined data management and reporting.

Remember to ensure the data is accurate, reliable, and up-to-date! If you have ImpactNexus’s software system, it will help you with this. Our team's support and tailored consulting ensure your ride is hassle-free.

Regarding your investment decision-making processes, we know integrating ESG factors requires careful consideration and expertise. You may need help assessing the materiality of ESG issues or incorporating them into traditional financial analysis. However, by continuously evaluating and improving ESG integration practices, by identifying gaps or areas for improvement and by collaborating with industry peers to share best practices, you will continuously improve the incorporation of ESG considerations into investment decision-making frameworks.

6. Communicate right‍

Engage with portfolio companies, regulators, employees, and other stakeholders to understand their sustainability preferences and expectations. As an investor, you may need help in effectively communicating your sustainability efforts and in responding to stakeholder demands.

By fostering meaningful dialogue with your stakeholders early on to understand their sustainability preferences and expectations, you will be on an excellent path to tailoring your disclosures and investment strategies accordingly and meeting their demands - all while enhancing transparency.‍

7. Stay Informed‍

Keep abreast of latest developments in SFDR regulations and guidance. At ImpactNexus, we use our systems to help you stay up-to-date and avoid falling behind, which could otherwise lead to regulatory consequences as the regulation climate constantly changes and updates itself.

Attending industry seminars, workshops, or webinars to stay informed about best practices and emerging trends in sustainable investing can also help guide you in the right direction.

8. Prepare Comprehensive Disclosures

We recommend starting to prepare your SFDR disclosures well in advance of the reporting period. Ensure your disclosures are accurate, complete, and transparent to enhance stakeholder credibility and trust.

9. Seek Expert Advice‍

SFDR regulations are relatively new, and more precise guidance on interpreting and implementing specific requirements may be needed. Many investors we talk to sometimes need help understanding their obligations and how to comply effectively.

If you need clarification on any aspect of SFDR compliance, seek advice from ESG consultants, legal experts, or industry associations. They can provide valuable insights and guidance tailored to your investment needs and objectives. A software solution like ImpactNexus can also help by giving you the tailored advice that you need.

‍Conclusion

Following this comprehensive SFDR guide for investors, you can ensure you're well-prepared for the next reporting period. Just to reiterate, SFDR compliance isn't just about meeting regulatory requirements - it's about integrating sustainability into your investment decisions and driving a positive impact for the future. So, let's take the necessary steps together, let's embark on a journey towards a more sustainable and resilient business environment. Let's make the process easy and enjoyable and let's strive for value creation with sustainability in mind.

‍Getting support

‍If you need individual support, please either reach out via email (help@impactnexus.io) or schedule a support call here.