What US companies need to know about SFDR and its implications on transatlantic investment strategies

Our industry is engaged in an important dialogue to improve sustainability through ESG transparency and industry collaboration. This article is a contribution to this larger conversation and does not necessarily reflect GRESB’s position.

The Sustainable Finance Disclosure Regulation (SFDR) is a set of regulations from the European Union that aims to provide greater transparency and open access around the sustainability information of financial products in order to channel private investment towards sustainable investments. Asset managers and other financial market participants must publicly disclose ESG information about their investment decisions and financial products, regardless of whether or not they are listed as sustainable. Since the initial phase in of SFDR Level 1 in March 2021, the Regulatory Technical Standards (RTS) for SFDR Level 2 were published and are now mandatory from January 2023. 

The SFDR is the first product labeling regulation of its kind to introduce strict labeling for ESG-related products, and improved oversight and requirements from this regulation can mitigate greenwashing and false claims that have been previously unrestricted. SFDR defines and introduces transparency requirements on financial products’ characteristics that can be used and compared to assess their degree of sustainability. The regulatory requirements of SFDR focus on the transparency of consideration of sustainability risks, sustainable investments in economic activities that contribute to environmental or social objectives, and consideration of Principal Adverse Impacts (PAI) on sustainability factors.

Under SFDR, investment products are classified as one of the following: Article 8 (Light Green) funds integrating ESG factors, considered to be more focused on financial materiality, Article 9 (Dark Green) funds focusing on sustainable economic activities or impact, and/or aiming to reduce carbon emissions in line with the Paris Agreement, or Article 6 (All other funds) with no specific ESG considerations integrated into the investment process.

The SFDR complements corporate disclosure rules from the EU’s Non-Financial Reporting Directive (NFRD) and the expanded requirements under the NFRD’s successor, the Corporate Sustainability Reporting Directive (CSRD). These laws are part of a larger sustainable finance package the European Commission adopted to increase financing toward climate-friendly activities in the EU, contributing to the EU’s larger effort to become climate neutral by 2050. 

As the European Union (EU) continues to lead the way in sustainable finance regulations, U.S. companies should be aware of the Sustainable Finance Disclosure Regulation (SFDR) and its potential impact on transatlantic investment strategies. The goals of this regulation, removing barriers that hinder investors from getting the sustainability data they need, while also combating greenwashing, are applicable across regional lines and will likely impact the scope and direction of regulatory advances in other countries going forward. 

While the SFDR primarily applies to financial institutions and advisors with more than 500 employees operating in the EU, non-EU firms will be indirectly impacted due to EU subsidiaries, services offered in the EU, and market pressure. U.S. companies that sell to EU-based clients or are domiciled in the EU must also adhere to SFDR regulations and requirements for each fund or product they market to EU citizens. U.S. companies should begin preparing for similar initiatives, seeing as the U.S. Securities and Exchange Commission (SEC) has already begun asking companies to provide human capital resources disclosures on Form 10-Ks and is set to require climate related disclosures in April 2023. 

SFDR Global Implications:

• Investor expectations: As EU-based investors become more aware of ESG risks and opportunities, they may start to demand higher levels of ESG disclosure and performance from their investment managers and advisors, which could impact US companies that do business with EU-based clients or investors. U.S. companies must be prepared to meet these demands to maintain their EU client base.
• Compliance costs: The SFDR may impose additional compliance costs on companies, particularly if they need to make significant changes to their existing ESG policies and disclosures.
• Regulatory developments: The SFDR is part of a broader trend toward increased ESG regulation globally, which could have implications for U.S.-based companies in the future.
• Opportunities: By meeting the SFDR’s requirements, U.S.-based companies can demonstrate their commitment to sustainability and gain a competitive advantage in the EU market. Furthermore, the SFDR’s focus on sustainable investments in economic activities that contribute to environmental or social objectives can create new business opportunities for U.S. companies in the EU market.

Complying with SFDR:

1. Understand the Taxonomy Regulation: SFDR is closely linked to the EU’s Taxonomy Regulation, which provides a framework for identifying environmentally sustainable economic activities. U.S. companies that do business with EU-based clients or investors should familiarize themselves with the criteria set out in the Taxonomy Regulation, as it may affect the classification of their investment products under the SFDR.
   
2. Develop an ESG Disclosure Strategy: To comply with SFDR’s requirements, U.S. companies may need to disclose detailed information about the sustainability risks and impacts of their investment products. This can be challenging, particularly for companies with complex supply chains or operations in multiple jurisdictions. To address these challenges, U.S. companies may need to develop an ESG disclosure strategy that includes clear policies and procedures for collecting, analyzing, and reporting sustainability data.
   
3. Leverage ESG Data Management Tools: To streamline the ESG disclosure process, U.S. companies may want to consider leveraging ESG data management tools that can help them collect and analyze sustainability data in a more efficient and standardized way. For example, many companies are adopting software platforms that can automatically extract ESG data from public disclosures and analyze it using predefined metrics and frameworks such as SASB or GRI.
   
4. Align with Global Reporting Standards: To ensure consistency and comparability of ESG disclosures across different markets and jurisdictions, U.S. companies may want to consider aligning their reporting practices with global reporting standards such as the Task Force on Climate-related Financial Disclosures (TCFD), GRI, and SASB. This can help companies meet the SFDR’s disclosure requirements while also providing investors with more meaningful and useful information.
   
5. Engage with Stakeholders: To demonstrate their commitment to ESG issues and build trust with investors and other stakeholders, U.S. companies may want to engage with them regularly on sustainability matters. This can include conducting regular ESG audits and engaging with investors on sustainability performance and disclosure. By engaging with stakeholders, U.S. companies can build stronger relationships and gain a better understanding of their expectations and concerns around ESG issues.

By Caroline Pittard, Sustainability Content Specialist at Watchwire.