Is the SFDR achieving its aims?

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BNY Mellon Investment Management head of responsible strategy Kristina Church highlights the SFDR’s successes and challenges.

Across all sectors of the economy, there is urgency for industry participants to join the transition to net zero and affect change through social issues. Investors increasingly need to look at companies through multiple lenses: people, planet as well as profitability.

Driven by a lack of urgency to meet these objectives, the Sustainable Finance Disclosure Regulation (SFDR) launched on 10 March 2021 with the expressed aim of tackling greenwashing and enabling greater transparency within finance. One year on, we look back at its implementation, and highlight areas for continued development in the responsible investing landscape.

A step in the right direction

It is vital that the industry is able to convey as much clarity around responsible investing to clients as possible, and this was an area that was lacking in the regulatory environment prior to the SFDR’s implementation.

We have welcomed the SFDR as a positive start, in so much as it helps retail and institutional investors better understand how responsibly their portfolios are managed. The legislation has corralled investors to focus on responsible investing and has been a necessary wake-up call for funds slow to act on the urgency of climate change, and other key sustainability issues.

The SFDR has, however, added a layer of intricacy and complexity to responsible investing, and as a result, discrepancies and grey areas remain.

Hurdles persist

We view responsible investing as a spectrum, and by nature, regulatory frameworks can blur some of the nuances of that spectrum.

One investor’s ‘responsible investment’ (RI) can be another’s ‘sustainable investment,’ and what one investor understands as ‘impact investing,’ another may term as ‘ESG integration’. Given the lack of standardised terminology, there is a need to make sure RI-related terms are clearly defined to ensure consistency across the investment landscape.

Quality and consistency of data are also extremely important considerations. Discrepancy between third-party data providers and the increasing need for more scenario-based, forward-looking corporate data continues to remain problematic. The SFDR addresses reporting and disclosure requirements for the asset management industry, but data remains voluntary and imperfect on the corporate side.

There is a need for global alignment between all key stakeholders to develop mandatory commitments for the reporting of environmental, social and governance (ESG) issues. The mandatory reporting of consistent, standardised, high-quality corporate data could prove a critical factor in enabling investors to have further confidence in the products and investment vehicles in which they are investing.

Many investors instinctively feel a company which is in transition cannot be labelled as sustainable. To date, many RI flows have crowded into companies which already have the highest environmental or social ratings, but this can create overcrowding risk.

There are large chunks of the economy which have yet to align to net zero, and many of the so-called “hard-to-abate” sectors, i.e. those with high carbon intensity and the highest projected costs to decarbonise, are sectors which investors might shun entirely when taking into consideration regulatory standards such as the SFDR. But these are also sectors such as chemicals, steel, heavy-duty transport and cement which are vital to future economic growth. For the wider economy to globally transition, these companies must now work out the best ways to decarbonise and have the most urgent need for investor capital to do so.

The pandemic has brought the social aspect to the fore and raised the importance of equality and a “just transition” for all. Companies which can demonstrate good governance, are committed to strong environmental stewardship and which are socially progressive are increasingly being recognised as more attractive investments.

We’re currently seeing that biodiversity and social issues are rising on political agendas, just as climate has over the last few years. However, there are still considerable complexities around measuring and reporting on nature-related and social considerations within an investment strategy. Particularly as social values can differ greatly by geography, taking a one-size investment approach across markets is unlikely to work in the near term.

It’s imperative that these social aspects are not ignored by the investment community, and social impacts are interweaved with the transition to net zero. The latest IPCC report1 very clearly lays out the direct link between climate, ecosystems (including biodiversity) and human society. We expect 2022 to be the year when regulators focus on the need to clearly define a more meaningful set of social classifications or taxonomy.

Looking ahead

Responsible investing should ultimately be mainstream, present in all investing. In the future, we expect to see greater focus on identifying companies that aren’t best-in-class today, but which are transitioning to align with a lower carbon world or are putting in place policies to ensure a better impact on the environment and society. SFDR is a step in the right direction but there are still many hurdles to overcome as an industry.

1 The Intergovernmental Panel on Climate Change (IPCC) finalized the second part of the Sixth Assessment Report, ‘Climate Change 2022: Impacts, Adaptation and Vulnerability’ 22 February 2022.

936502 Exp: 19 September 2022

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