The SFDR is an intricate mesh of duties, whose implementation requires careful orchestration. The implementation work for the regulation will go on during the year 2021 as the ESA’s final Level II requirements were published only on 2 February 2021 (“draft RTS”), and will likely enter into force by 1 January 2022.
One of the cornerstones – and key challenges – of the implementation process is the classification of financial instruments (including managed portfolios), on which the determination of the nature and scope of the disclosures hinges. “ESG products” in the sense of the SFDR are only those which meet the requirements of Art. 8 and/or Art. 9 SFDR, i.e. products promoting environmental or social characteristics (Art. 8) and those that pursue a sustainable investment objective (Art. 9). While these products are attractive for promotion, the regulatory hurdles are quite high, as many players have discovered. For those products that do not meet the respective conditions, it must be ensured that no “E” or “S” strategy or sustainability impact is implied, as this would constitute mis-selling. Indeed, experience so far has shown that the most commonly observed product type are Art. 6 funds (which consider sustainability risks) which will be considered as “mainstream” products. In contrast, the highest category – Art. 9 funds – is encountered only on very rare occasions, due to the very high standards set by the regulation.
Beyond being a technical exercise, the product classification may necessitate a re-examination of the overall sustainability-related strategy and communication. All the more so as the pending amendments to the MiFID II regime link up with the SFDR classification for the determination of clients’ ESG preferences. Those who want to position themselves as “green” must ensure they have a product palette to match the claim.
Another focus is the disclosure of principal adverse impacts of investment decisions on sustainability factors (“PASI”), which is mandatory for firms with more than 500 employees. For many, the gathering of the necessary data from internal and external providers must be prioritized in order to adhere to the website and periodic reporting duties. This may involve negotiating new contracts or sourcing additional data or IT providers. Internally, the corresponding reporting structures must be established and methods to take the PASI into account as part of the investment decision process.
Due to the variety of different workstreams which are necessarily involved in the SFDR implementation, coordination and consistency is vital: A range of policies and procedures must be assessed and adapted in order to guarantee an adequate internal framework. Policies on the integration of sustainability risk into the investment decision-making process must be evaluated, along with the remuneration policies and how these are consistent with the integration of sustainability risks. Where PASI are considered, information on the respective due diligence policies must be published. Implications for the broader policy framework must also be addressed in order to avoid inconsistencies and to embed the provisions in the existing control and reporting framework. Coordination with IT will be key to secure a timely “go live”. Client contracts form a further workstream to be aligned with the remaining preparations.
Many have barely made it past the finish line for 10 March but it is important to bear in mind that this is just the beginning. Due to the complexity and breadth of the covered topics, a successful SFDR implementation must have the big picture in mind – both from a regulatory as well as a strategic and business-minded perspective.