INTRODUCTION
The Sustainable Finance Disclosure Regulation (''SFDR'') aims to establish a harmonised approach on sustainability-related disclosures provided to investors domiciled in the European Union (''EU'').
SFDR imposes sustainability-related disclosure and transparency obligations on both the asset manager (i.e., at the entity level) and on the fund which it manages (i.e. at the product level).
SFDR establishes three principal areas where sustainability related disclosures must be made: fund prospectus; fund periodic reports; and website disclosures.
There are separate obligations that apply to both asset managers and the funds which they manage. We examine in further detail in this guide some of the key requirements that apply under SFDR to both asset managers (in respect of the entity level requirements) and to the funds they manage (in respect of the product level requirements).
MAPLES SUSTAINABLE INVESTING GROUP
The Maples Group is fully committed to the goals and initiatives of sustainability. We are highly focused on the impact that environmental, social, and governance ("ESG") and responsible investment will have on the financial services sector.
Our Sustainable Investing Group is a dedicated, multi-disciplinary team of ESG and sustainable finance experts drawn from our Funds & Investment Management, Finance, Banking, Corporate, Real Estate and Dispute Resolution teams. Our global footprint ensures that we have exposure to sustainable investing trends and developments. It also enables us to draw on the experiences and expertise of the entire Maples Group, to develop a uniform and consistent approach to ESG initiatives for our global clients.
Sustainable Investing in Europe
At a European level, our sustainability team is highly focused on the impact of the EU’s Sustainable Finance Action Plan for the European asset management sector, in particular, the impact of SFDR, the Taxonomy Regulation and the Corporate Sustainability Reporting Directive.
Having a multi-jurisdictional European footprint allows our sustainability specialists to evaluate quickly how an EU regulatory requirement is being treated under both Irish and Luxembourg law, as well as compare and contrast positions taken by the Commission de Surveillance du Secteur Financier (''CSSF'') and the Central Bank of Ireland on a specific SFDR or sustainable finance issue. We are also able to draw on the experiences and expertise of the entire Maples Group, including our ESG award winning colleagues in funds and fiduciary services, to develop and deliver ESG solutions for our global clients.
How We Can Help
We have collaborated with leading global asset managers and institutional investors operating in the EU to develop end-to-end SFDR compliance solutions at both the operational level within the asset manager and at the underlying fund / financial product level.
We can audit policies and procedures to identify those affected by SFDR, and best advise how those policies can be enhanced to integrate the consideration of sustainability risks into the investment decisionmaking process and overall risk framework.
At the underlying fund / financial product level, we can assist with SFDR financial product analysis, including undertaking a full review of all offering documents and marketing collateral to assist with the determination of SFDR product categorisations, as well as helping prepare Article 8 and Article 9 pre-contractual, website and periodic disclosures.
The Maples Group also offers a range of other sustainable solutions to support our clients including data and reporting, fund and manager ESG certification and the Maples Sustainability Platform is designed to support the operational and compliance requirements of SFDR compliant Article 8 or 9 funds. To find out more about our sustainable capabilities and related initiatives, please visit our sustainable investing resource hub here
SFDR - AT A GLANCE
WHAT IS IT?
SFDR seeks to establish a harmonised approach on sustainability-related disclosures provided to investors domiciled in the EU. Broadly speaking, SFDR imposes sustainability-related disclosure and transparency obligations on both the asset manager (i.e., at the entity level) and on the fund which it manages (i.e., at the product level).
WHO IS IN SCOPE?
SFDR applies to asset managers (and investment advisers) domiciled or operating in the EU who are managing or distributing funds to European investors.
DOES IT APPLY TO NON-EU ASSET MANAGERS?
Yes, if those non-EU asset managers are managing EU funds or marketing non-EU funds via national private placement regimes in the EEA, they will be required to comply with SFDR.
WHAT DOES IT REQUIRE?
SFDR requires asset managers to provide more transparency on how they integrate sustainability risks into their investment decisions and the consideration of how principal adverse sustainability impacts the investment process.
DOES SFDR HAVE CATEGORIES OF SUSTAINABLE PRODUCTS?
Yes, SFDR identifies three types of funds and distinguishes between them depending on the extent of ESG integration. The three types being colloquially known as an Article 6 fund, an Article 8 fund and an Article 9 fund.
WHAT IS AN ARTICLE 6 FUND?
A fund that either does or does not integrate the consideration of sustainability risks into its investment decision making process.
WHAT IS AN ARTICLE 8 FUND?
A fund that promotes environmental and/or social characteristics, investing in companies which follow good governance practices.
WHAT IS AN ARTICLE 9 FUND?
A fund that has a sustainable investment objective.
WHAT IS A SUSTAINABLE INVESTMENT UNDER SFDR?
It is an investment that contributes towards an environmental or social objective chosen for, or characteristics promoted by, a fund, provided that (i) the activities of that investment do no significant harm ("DNSH") to such environmental or social objectives / characteristics; and (ii) that investment follows good governance practices.
Determining what is deemed a sustainable investment is subjective; asset managers are afforded absolute discretion in designing their own framework to assess if an investment qualifies as sustainable.
WHAT ARE THE MIFID SUSTAINABILITY PREFERENCES?
EU based distributors must assess an investment's suitability for retail investors. Within that assessment is a requirement to establish that investor's sustainability preferences. Distributors can only make investment recommendations based on alignment with that investor's sustainability preferences.
HOW DO YOU SATISFY THE MIFID SUSTAINABILITY PREFERENCE?
In order to ensure a fund meets a retail investor’s sustainability preferences, that fund must do at least one of the following: (i) commit to a minimum holding of sustainable investments; (ii) commit to a minimum holding of Taxonomy-aligned investments; or (iii) consider Principal adverse impacts ("PAI") of their investment decisions on sustainability factors, at the product/fund level.
WHAT ARE THE EU PARIS-ALIGNED BENCHMARK EXCLUSIONS ( "PAB EXCLUSIONS")?
The PAB Exclusions are:
a. companies involved in any activities related to controversial weapons;
b. companies involved in the cultivation and production of tobacco;
c. companies that benchmark administrators find in violation of the United Nations Global Compact ("UNGC") principles or the Organisation for Economic Cooperation and Development ("OECD") Guidelines for Multinational Enterprises;
d. companies that derive 1 % or more of their revenues from exploration, mining, extraction, distribution or refining of hard coal and lignite;
e. companies that derive 10 % or more of their revenues from the exploration, extraction, distribution or refining of oil fuels;
f. companies that derive 50 % or more of their revenues from the exploration, extraction, manufacturing or distribution of gaseous fuels; and
g. companies that derive 50 % or more of their revenues from electricity generation with a GHG intensity of more than 100 g CO2 e/kWh.
WHAT ARE THE EU CLIMATE TRANSITION BENCHMARK EXCLUSIONS ("CTB EXCLUSIONS")?
The CTB Exclusions are:
a. companies involved in any activities related to controversial weapons;
b. companies involved in the cultivation and production of tobacco; and
c. companies that benchmark administrators find in violation of the UNGC principles or the OECD Guidelines for Multinational Enterprises.
WHAT IS GREENWASHING?
A practice where sustainability-related statements, declarations, actions, or communications do not clearly and fairly reflect the underlying sustainability profile of an entity, a financial product or a financial service.
WHAT DOES TAXONOMY-ALIGNED MEAN?
The Taxonomy Regulation establishes a framework to classify environmentally sustainable economic activities (otherwise known as Taxonomy-aligned) by setting harmonised criteria for determining whether an economic activity qualifies as environmentally sustainable.
WHAT ARE PRINCIPAL ADVERSE IMPACTS?
PAIs and sustainability risks are interrelated though different concepts. The concept of PAI intends to capture the impact of investment decisions that results in negative effects on sustainability factors relating to environmental, social and employee matters, respect for human rights, anti-corruption and anti-bribery matters.
WHERE DO I MAKE THE SUSTAINABILITY RELATED DISCLOSURES?
Asset managers managing or distributing Article 8 or Article 9 funds must make sustainability related disclosures in its (i) fund prospectus; (ii) website; and (iii) periodic reports.
FOCUS ON PRODUCTS
SFDR identifies three types of products, otherwise known as an Article 6 fund, an Article 8 fund and an Article 9 fund, each with their own requirements for pre-contractual and periodic disclosures.
Article 6 Funds
An Article 6 fund is a fund that either does or does not integrate the consideration of sustainability risks into its investment decision making process.
Pre-Contractual Requirements
There are no prescribed mandatory SFDR pre-contractual templates that are required to be completed for an Article 6 fund. Rather, the pre-contractual disclosure requirements (outlined below) should be included in the main body of the fund prospectus.
Asset managers of Article 6 funds are responsible for ensuring that the fund prospectus includes a disclosure on the manner in which ''sustainability risks'' are integrated in investment decisions in respect of the fund. Compliance is on a ''comply or explain'' basis so if sustainability risks are not integrated into the investment decision-making process, a clear and concise explanation for the reasons must be included as to why not.
For an Article 6 fund, disclosure is also required to be included in the prospectus in compliance with Taxonomy Regulation requirements which provide ''Theinvestmentsunderlyingthisfinancial productdonottakeintoaccounttheEUcriteriafor environmentallysustainableeconomicactivities.’'
Periodic Reporting Requirements
In respect of the periodic reporting requirements for an Article 6 fund, unlike for Article 8 and Article 9 funds (which we discuss below), there is no mandatory SFDR periodic reporting template required to be completed.
A disclaimer statement should be included in the financial statements of the Article 6 fund to provide that the fund has been categorised as an Article 6 fund and that for the purpose of the Taxonomy Regulation the investments underlying the Article 6 fund do not take into account the EU criteria for environmentally sustainable activities.
Article 8 Funds
An Article 8 fund is a fund that promotes environmental and/or social characteristics, provided that the companies in which the investments are made follow good governance practices.
Article 8 funds are growing rapidly, both in number and AUM size. The existing SFDR framework does not apply any minimum sustainability criteria or thresholds for what constitutes an Article 8 fund. As a result, the Article 8 category has become quite a broad church.
Pre-Contractual Requirements
For Article 8 funds, asset managers must ensure that the fund prospectus includes disclosures in respect of how the fund promotes environmental and/or social characteristics. This includes the completion of the mandatory Article 8 SFDR precontractual annex, some of the key features/questions of which we have set out below.
Requirement
What environmental and/or social characteristics are promoted by the fund?
Description
The environmental and/or social characteristics promoted by the Article 8 fund must be disclosed. This should also include details on whether a reference benchmark has been designated for the purpose of attaining the environmental and/or social characteristics promoted by the Article 8 fund.
What sustainability indicators are used to measure the attainment of each of the environmental and/or social characteristics promoted?
How do the sustainable investments that the financial product partially intends to make, not cause significant harm to any environmental and/or social sustainable investment objective?
What are the asset allocation requirements?
What are the binding elements of the investment strategy, and what is the policy for assessing good governance?
Details of the sustainability indicators used to measure how the environmental and/or social characteristics promoted by the Article 8 fund are obtained must be disclosed. The sustainability indicators are not prescribed by SFDR, however the European Supervisory Authorities (''ESAs'') have clarified that the use of PAI indicators may be used to measure the attainment of environmental and/or social characteristics and do not require any prior PAI consideration at an entity level or product level.
Where an Article 8 fund has a proportion of investments in sustainable investments pursuant to SFDR, a disclosure must be included in the Article 8 SFDR pre-contractual annex as to how those investments do not cause significant harm to any environmental and/or social investment objective as prescribed by SFDR.
A percentage of the minimum proportion of the investments used to meet the environmental and/or social characteristics promoted by the Article 8 fund must be disclosed in the pre-contractual annex
Asset managers need to include a brief summary of the investment strategy, including any binding elements imposed by the asset manager in seeking to attain the environmental and/or social characteristics promoted by the fund. These binding elements are increasingly being viewed by regulators / depositaries as being akin to investment restrictions. The asset manager also needs to include a summary of its policy on how it assesses good governance at the underlying investee company level.
To what minimum extent are sustainable investments with an environmental objective aligned with the EU Taxonomy?
Are Principal Adverse Impacts considered at the fund level?
Where an Article 8 fund makes sustainable investments with an environmental objective aligned with the EU Taxonomy, the minimum extent of those investments must be disclosed. However, there is no requirement for an Article 8 fund to have any sustainable investments.
Where consideration of PAI is at the product fund level, this may be undertaken by asset managers on a fund by fund basis. A disclosure must be included detailing which PAI. MiFID sustainability preferences have had a significant impact on Article 8 product design. The vast majority of managers of Article 8 funds are ensuring compliance with the MiFID sustainability preferences by considering the PAI of their investment decisions on sustainability factors at the Article 8 product level.
Periodic Reporting Requirements
For Article 8 funds, asset managers must disclose, in the form of the mandatory SFDR periodic reporting annex, a description of the extent to which environmental and/or social characteristics promoted by the fund were met. The template must be annexed to the periodic report (which for UCITS and AIFs will be their annual accounts).
Broadly speaking, the SFDR periodic reporting annex follows the pre-contractual one, so when completing it, asset managers are effectively revisiting those pre-contractual statements and describing how the fund performed in respect of each one during the relevant reporting period. When completing the periodic report annex, it should be looked at side by side with the pre-contractual disclosure template as effectively they are ex ante and ex post disclosures of the same detailed information.
The SFDR periodic reporting annex also includes a number of questions which contemplate a yearon-year comparison (most notably in respect of the performance of sustainability indicators) where managers must compare how the fund performed as against the previous reporting period.
Website Disclosure Requirement
For Article 8 funds, website disclosures must include information on the environmental and/or social characteristics promoted by the Article 8 fund consistent with the precontractual disclosures.
In addition, SFDR requires Article 8 funds to disclose information under mandatory headings, prescribing what should be included under each heading. The website disclosures must be housed in a dedicated section entitled "Sustainability Related Disclosures".
Article 9 Funds
An Article 9 fund must have a sustainable investment objective, as such its portfolio needs to consist of all, or substantially all, sustainable investments.
While the number of Article 9 funds has been relatively limited to date, we expect this to increase following the European Commission reaffirming that managers have autonomy in how and what they classify as a sustainable investment, together with an increased confidence in data flows supporting these classifications.
Pre-Contractual Requirements
Asset managers of Article 9 funds are required to complete the Article 9 SFDR pre-contractual annex, some of the key features/questions of which we have set out below.
Requirement Description
What is the sustainable investment objective of the Article 9 fund?
What sustainability indicators are used to measure the attainment of the sustainable investment objective of the financial product?
A disclosure must be included in the Article 9 SFDR pre-contractual annex on what is the sustainable investment objective pursued by the fund and how the sustainable investments contribute towards that sustainable investment objective. This should also include details on whether a reference benchmark has been designated for the purpose of attaining the sustainable investment objective. It is worth noting that determining what is deemed a sustainable investment is subjective and asset managers are afforded absolute discretion in designing their own framework to assess if an investment qualifies as sustainable.
Details of the sustainability indicators used to measure how the sustainable investment objective of the Article 9 fund is achieved must be disclosed in the Article 9 SFDR pre-contractual annex. As outlined above (under the section ''Article 8 funds'') the sustainability indicators are not prescribed by SFDR, however the use of PAI indicators may be used to measure the attainment of the sustainable investment objective and do not require any prior PAI consideration at an entity level or product level.
Are Principal Adverse Impacts considered by the Article 9 fund?
What is the asset allocation and the minimum share of sustainable investments?
To what minimum extent are sustainable investments with an environmental objective aligned with the EU Taxonomy?
Where consideration of PAI is at the product/fund level, this may be undertaken by asset managers on a fund by fund basis. A disclosure must be included in both the fund prospectus and on the website in respect of the Article 9 fund as to whether PAI is considered at the Article 9 product level.
A percentage of the minimum proportion of the investments used to meet the sustainable investment objective must be disclosed in the Article 9 SFDR pre-contractual annex.
Where an Article 9 fund makes sustainable investments with an environmental objective aligned with the EU Taxonomy, the minimum extent of those investments must be disclosed.
Periodic Reports
For Article 9 funds, asset managers must disclose, in the form of the SFDR periodic reporting annex, a description of the extent to which the sustainable investment objective was attained during the period. The template must be annexed to the periodic report (which for UCITS and AIF will be their annual accounts).
Again the Article 9 SFDR periodic reporting annex follows the pre-contractual one, so when completing, asset managers are effectively revisiting those pre-contractual statements and describing how the fund performed in respect of each one during the relevant reporting period, (i.e. ex ante and ex post disclosures of the same detailed information).
The SFDR periodic reporting template includes a number of questions which contemplate a year-on-year comparison (most notably in respect of the performance of sustainability indicators) where managers must compare how the fund performed against the previous reporting period.
Website Disclosure Requirement
For Article 9 funds, disclosures must include information on the sustainable investments promoted by the Article 9 fund consistent with the pre-contractual disclosures.
SFDR also requires Article 9 funds to disclose information under mandatory headings, prescribing what should be included under each heading. The website disclosures must be housed in a dedicated section entitled "Sustainability Related Disclosures".
SUSTAINABILITY RELATED FUND NAMES
Article 8 funds and Article 9 funds should ensure adherence to ESMA's final ESG fund naming guidelines (''Guidelines''). For any proposed newly established Article 8 funds and Article 9 funds consideration should be given to the name in light of the Guidelines. Some of the key provisions of the Guidelines that should be considered are as follows:
Term used in Name
Sustainabilityrelated
Description of Key Term used in Name
Any terms only derived from the base word "sustainable", e.g. "sustainably", "sustainability" etc.
Thresholds / Asset Allocation
80% of assets must be used to meet the environmental and/or social characteristics or sustainable investment objectives in accordance with the binding elements of the investment strategy as disclosed in the SFDR pre-contractual disclosure; and there must be a commitment to invest "meaningfully" in sustainable investments (i.e. 50% of assets). Exclusions: PAB Exclusions
Transitionrelated
Any terms derived from the base word "transition" e.g. "transitioning", "transitional" etc. and those terms deriving from "improve", "progress", "evolution", "transformation", "netzero", etc.
Social-related Any words giving the investor any impression of the promotion of social characteristics, e.g. "social", "equality" etc.
Governancerelated
Environmentalrelated
Impact-related
Any words giving the investor any impression of a focus on governance, e.g. "governance", "controversies" etc
Any words giving the investor any impression of the promotion of environmental characteristics, e.g., "green", "environmental", "climate", etc. These terms may also include "ESG" and "SRI" (Socially Responsible Investments) abbreviations.
Any terms derived from the base word "impact", e.g., "impacting", "impactful", etc.
As above, 80% of assets must be used to meet the E&S characteristics or sustainable investment objectives. Funds using "transition-" related terms in their names should also ensure that investments used to meet the threshold are on a clear and measurable path to social or environmental transition.
Exclusions: CTB Exclusions
As above, 80% of assets must be used to meet the E&S characteristics or sustainable investment objectives.
Exclusions: CTB Exclusions
As above, 80% of assets must be used to meet the E&S characteristics or sustainable investment objectives
Exclusions: PAB Exclusions
As above, 80% of assets must be used to meet the E&S characteristics or sustainable investment objectives. Funds using "impact"-related terms in their names should also ensure that investments used to meet the threshold are made with the objective to generate a positive and measurable social or environmental impact alongside a financial return.
Exclusions: PAB Exclusions
FOCUS ON ASSET MANAGERS
SFDR imposes sustainability-related disclosure and transparency obligations on asset managers (at the entity level).
SFDR requires asset managers to provide more transparency on how they integrate sustainability risks into their investment decisions and the consideration of principal adverse sustainability impacts in the investment process.
In order to comply with SFDR, disclosures must be made by asset managers on that entity's website, in its remuneration policies and certain policies and procedures. We have set out below some of the key requirements for asset managers under to SFDR.
Website Disclosures
SFDR website obligations require both entity level and product level disclosures with the asset manager being the entity responsible for these disclosures. It is important that asset managers have controls in place from both a compliance and operational perspective to ensure that all website disclosures adhere to both the SFDR content and location rules.
Asset managers are required to disclosure information on their websites including (i) information about their policies on the integration of sustainability risks in their investment decision-making process; (ii) how their remuneration policies are consistent with the integration of sustainability risk; and (iii) whether they consider PAI of investment decisions on sustainability factors (as detailed below).
Product Level Disclosures
As noted above, asset managers must publish specific disclosures for all Article 8 and Article 9 funds under management. These disclosures must be housed in a separate section of the website entitled "Sustainability Related Disclosures" which should be located in the same part of the website where other fund specific information is housed.
As an overriding requirement, asset managers must ensure any general sustainability information published in respect of the products' sustainability credentials are consistent with the corresponding SFDR disclosures (relating to those products), and that all sustainability disclosures appearing on their websites are clear, fair and not misleading.
SFDR website disclosures must be kept up to date. As such, asset managers should have processes in place to continually review their sustainability related website disclosures to ensure such text is prepared and published in a manner consistent with their SFDR regulatory disclosures and requirements.
Integration of Sustainability Risks
As outlined above, under SFDR asset managers are responsible for ensuring that disclosure is included in the funds' prospectus in respect of the integration of sustainability risks in the investment decision making process.
There are a number of additional obligations imposed on management companies which requires them to:
• integrate sustainability risks in the management of funds;
• take into account sustainability risks as part of the due diligence in the selection and ongoing monitoring of investment; and
• capture the procedures to manage sustainability risks in the risk management policy.
Remuneration Policies
Under SFDR, asset managers must include in their remuneration policies information on how these policies are consistent with the integration of sustainability risks and this information must also be published on their website.
Principal Adverse Impacts
Consideration of PAIs at entity level is on a ''comply or explain'' basis, save for certain types of asset managers who must undertake the PAI reporting on a mandatory basis. By way of example, asset managers with an average number of more than 500 employees (directly or at a subsidiary level), are required to consider PAI (unless the relevant asset manager is caught by one of the exemptions (i.e. the 500 employee test)).
If an asset manager chooses to opt in for PAI, it must consider the adverse impacts of its investment decisions on sustainability factors with respect to every fund under management. This obligation is distinct from considering PAI at the product level.
Under SFDR asset managers are required to publish and maintain certain information on their websites relating to the adverse impacts of their investment decisions on sustainability factors. Asset managers who opt out of PAI consideration need to disclose on their website the rationale for doing so.
CONTACTS
For further information please contact a member of the Maples Sustainable Investing Group:
IAN CONLON PARTNER
Ireland ian.conlon@maples.com
RICHARD O'DONOGHUE PARTNER Ireland richard.odonoghue@maples.com
VITTORIA TARAKDJIAN ASSOCIATE Luxembourg vittoria.tarakdjian@maples.com
KIERAN FOX DIRECTOR Business Development Europe kieran.fox@maples.com
NIAMH O'SHEA PARTNER
Ireland niamh.oshea@maples.com
MICHELLE BARRY PARTNER Luxembourg michelle.barry@maples.com
DECLAN MCHUGH SENIOR VICE PRESIDENT Head of Maples Fund Management declan.mchugh@maples.com
MICHAEL PAÍRCEÍR SENIOR VICE PRESIDENT Dublin michael.pairceir@maples.com
