By Fani Xylouri, Sustainability Services & Impact Reporting Manager at Grant Thornton Luxembourg.
Only four months are left before the EU’s Sustainable Finance Disclosure Regulation (SFDR) comes into force. While the regulation is expected to have a major impact on both financial participants and advisers, not all players are prepared to comply with the new disclosure obligations.
SFDR, the new EU regulation on sustainability-related disclosures is at the epicenter of discussions of the professionals in the financial sector. These discussions mostly revolve around the interpretation of the definitions of the adverse sustainability impacts and disclosure obligations at a product level. Even if, the confusion seems inevitable, the finalisation of the most expected supplementing regulatory technical standards (RTS) just before the end of 2020 would bring clarity and eventually complete the picture of how the legislation is intended to apply.
Unwinding the skein
The term ESG refers to environmental, social, and corporate governance factors when measuring the sustainability impact of an investment. ESG and sustainability as a whole are multilayered and complex systems whose components are both interlinked and interdependent. In reality, ESG factors cannot be separated from the way firms do business. It is essential to understand the impacts on these factors due to business operations and in turn, the related risks that occur to business as they derive from the decision making process. Overall, a strong ESG performance plays an essential role in a business’s sustainable and long-term value creation.
SFDR (EU 2019/2088) focuses on the mobilisation and reorientation of capital flows towards sustainable investment to achieve the EU’s sustainable and inclusive growth objectives. It aims to provide greater transparency on the management of the financial risks that stem from environmental and social issues. Therefore, the purpose is to promote future-proof, long-term focused financial activity while preventing greenwashing.
In particular, when referring to transparency in the investment process, the regulation implies:
- Openness on the consideration of ESG factors and related sustainability risks in investing
- Communication on the manner by which these factors are considered and the screening criteria used for this purpose, and
- Accountability by being responsible for one's firm or product disclosed impacts.
Meet the disclosure obligations
In practice, to ensure transparency and to prevent greenwashing, the new regulation requires the financial market participants and financial advisers to provide certain new disclosures and policies or update existing ones, in light of the applicable sectoral legislation, that include sustainability considerations. Additionally, pre-contractual disclosures need to be be updated and websites be reviewed on an ongoing basis concerning ESG objectives. Periodic reporting is also required to safeguard progress monitoring.
The CSSF recently confirmed that SFDR compliance date remains the 10th of March 2021. Therefore, the Luxembourgish financial sector must be ready to comply with the “Level 1”, high-level, principle-based disclosure requirements outlined by the text of SFDR. These requirements refer to Articles 3, 4, 5, and 6. On the contrary, the “Level 2” RTS which are required to supplement Articles 8, 9, 10, and 11 have yet to be finalised. The European Commission's latest letter explicitly states that the implementation of the RTS will be delayed "to a later stage".
Chasing the data
The challenge for financial market participants and financial advisers is real when it comes to data collection. To complete the disclosure requirements the collection of different data sets from multiple sources on the full spectrum of ESG factors is complex. The key sources may include data at a company level, financial product level, proprietary data, or other data from relative sources such as regulatory documentation. Besides, the collected data has to meet certain criteria to ease data aggregation and comparability in the long term. To do so, quality checks will have to be performed and specific metrics will have to be defined and used to prevent lack of data consistency and irrelevance. It is understood that there is a substantial gap between the requirements and the reporting data due to the lack of common reporting standards and publicly available data. However, with time it is expected that harmonised frameworks will be widely available. Until then, financial professionals can mostly rely on the disclosure of the most commonly accepted indicators and accessible qualitative information.
Analyse, monitor, disclose, repeat
As the implementation date is coming closer, the need for action is paramount. Depending on whether you provide portfolio management, investment advice, or both, SFDR requires a specific set of requirements from you. A phased, but holistic, approach may include the following steps:
- Analysis of the regulatory landscape and identification of requirements relevant to your activity
- Gap analysis between current practices and aspired approaches to ESG considerations
- A SDFR roadmap to define what needs to be modified (processes, policies, disclosures)
- Identification of ESG data stream and collection processes
- Monitoring the process and adjusting when required in line with regulatory updates (e.g.level 2 measures on AIFMD, UCITS, MiFID, and NFRD)
- Disclosure and reporting assessment on entity and product level on an annual basis
Starting now and for the next two years, incremental implementation of the regulatory changes that complete the EU Sustainable Finance Action Plan will apply. It won’t be long until ESG and sustainable investment will become mainstream and even the strongest ESG skeptics will be convinced to consider sustainability risks and impacts in their investment process.
Communicated by Grant Thornton Luxembourg
Publié le 16 décembre 2020