Who’s afraid of the SFDR?

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The European Sustainable Finance Disclosure Regulation (SFDR), which came into effect this year, sets out important transparency obligations and reporting requirements for investment managers. Here, Managers from across BNY Mellon and BNY Mellon Investment Management consider the pros and cons of the regulation and assess what it might mean for investors.

While much of the world’s attention has remained focused on the ongoing pandemic this year, 2021 saw the European investment industry reach a small but important landmark. March 10 witnessed the introduction of the SFDR – a set of regulations considered by the European Commission to be the core framework for its action plans on sustainable finance.

The SFDR introduces new requirements designed to trigger behavioural changes – encouraging financial market participants operating within the EU to integrate sustainability risks into their internal investment processes.

It also sets specific rules for how and what sustainability related information they need to disclose. One of the main aims of the new regulations is to eliminate so-called ‘greenwashing’ – or overstating claims about commitment to and actions on environmental protection.

Importantly, articles 8 and 9 of the SFDR are used to describe specific categories of financial products with a responsible investment or environmental, social and governance (ESG) focus, with Article 8 promoting characteristics such as environmental or social traits. In turn, Article 9 designated products have sustainable investment as a key objective.

The introduction of the SFDR has triggered a flurry of activity across the investment industry, with firms scrambling to meet the various deadlines for implementation. Yet, while its introduction has been broadly welcomed, some industry specialists stress the devil may lie in detail which is still to come.

A waiting game?

BNY Mellon head of public policy and government affairs EMEA, Ben Pott sees the SFDR as a positive step but believes many have seen this as a “test run” for the industry with much critical detail still to follow in coming months.

Usually European legislation comes into effect alongside a set of finalised technical standards,” he says. “The introduction of SFDR was novel in that a lot of the more detailed technical standards have yet to be finalised and it could be as late as mid-year 2022 before they are implemented. In the meantime, it is something of a waiting game for the investment industry.”

BNY Mellon Investment Management head of international product and governance Gerald Rehn also welcomes the SFDR’s arrival and is particularly hopeful it can tackle greenwashing. However, he too sees the latest implementation as merely the first step on a longer journey.

SFDR marks a significant step forward for the European funds industry, given the increased demand for ESG criteria from investors. We believe the implementation of SFDR is a starting point for the financial industry to enable more transparency for clients. When it comes to greenwashing, the spirit of the regulation is going in the right direction.

However, although this is welcome progress, it is only the first step and focuses somewhat narrowly on creating a prescriptive framework for classifying sustainability issues, while providing transparency on these issues for investors. The limited scope may penalise other ESG integrated approaches such as engagement and certain types of impact investing. We are also concerned that investors seeking ESG investment strategies may be unconsciously channelled into a narrow range of investment opportunities that ‘tick the box’ for SFDR purposes.

Diverging standards

According to Pott, the lack of an international framework on ESG standards beyond SFDR also remains a concern, with other jurisdictions looking to adopt their own unique standards, which may end up at odds with those of other markets. Post-Brexit, the UK is also looking closely at this area.

The G7 nations at their meeting in June indicated they want to create a global baseline for corporate disclosure. Yet several jurisdictions are moving ahead with developing their own standards and their own requirements. There is a fear international standard setters may be playing catch up with existing requirements,” says Pott.

The question is: to what extent will all the varying rules and regulations be complementary and to what extent will they actually converge? The last thing the asset management industry wants is a range of different sets of jurisdictional legislation and regulation that don’t quite fit with each other,” he adds.

Either way, Rehn believes the positives of SFDR – such as the likelihood of it boosting ESG-related investment – do need to be weighed cautiously against potential downsides.

So far the SFDR has provided a higher level of scrutiny of current ESG integration and research than ever before and it will certainly lead to more growth in the ESG space. We are already seeing a huge increase in the demand for responsible investing, including sustainable and impact products across the industry.

“We believe that overall, these regulations will succeed in channelling more money to companies building our sustainable economy. However, we continue to have concerns that SFDR encourages too narrow a definition of responsible investing and may result in the channelling of large pools of savers’ capital to a limited number of companies that already score highly in third party ESG data rankings. There is a danger this could fall at the expense of companies who could be in the process of transitioning to green investments,” he concludes.

Important information

https://www.bnymellonim.com/outlook/global-disclosure/

GE663183 Exp: 16 February 2022

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