Sustainable Finance Disclosure Regulations (SFDR) – European Union

What is the Sustainable Finance Disclosure Regulation (SFDR)?

The SFDR is a framework that provides a common language for financial market participants in the EU to disclose the sustainability attributes and impacts of their investment activities.

The regulation specifically requires financial market participants to disclose how they consider sustainability risks when making investment decisions, and how these decisions contribute to the broader sustainable development objectives of the EU.

The SFDR[1] went into effect in March 2021 and is considered a critical part of the EU’s Sustainable Finance Action Plan. 

Key Elements of the SFDR

The SFDR includes both core content categories as well as disclosure levels. The core content includes the following elements:

Principal adverse impacts

This disclosure element requires that management speaks to the negative impacts investment decisions have on the environment and society. It specifically requires participants to disclose how their investment activities influence a broad set of environmental and social issues. For example, participants will need to disclose how their investment decisions impact water supply and quality.

Integration of sustainability/ESG risks

This disclosure element requires detailed information about ESG policies and risk management processes. For example, participants will need to disclose if/how they integrate ESG issues into each stage of the investment process.

Sustainability/ESG information around financial products

This disclosure element requires vendors of sustainable finance products (like ESG funds) to detail how environmental, social, and governance issues impact decision-making and core activities within the firm, as well as how the product impacts broader sustainable development objectives.

There are two disclosure levels built into the SFDR. These are:

1. Entity level – this refers to the ESG attributes of the company or firm itself.
2. Product level – this refers to the ESG attributes of any financial products themselves. 

Who Should be Concerned About the SFDR and Why?

The regulation applies to all financial market participants (“FMPs”) and financial advisors (“FAs”) in the EU. It also includes FMPs with EU shareholders, and those marketing themselves in the EU, even if not based there. 

Examples of other, non-traditional FMPs that are affected include:

• Alternative investment fund managers.
• Investment firms that provide portfolio management and/or pension products.
• Managers of a qualifying venture capital or social venture fund.
• Insurance companies offering insurance-based investment products.
• Institutions for occupational retirement provision or management company for UCITS (Undertakings of the Collective Investments in Transferable Securities).

Failure to comply with the SFDR can result in reputational damage, legal liability, and regulatory sanctions.

On the other hand, compliance with the SFDR can help FMPs differentiate themselves from competitors, attract new clients (who prioritize sustainability and/or are facing their own ESG-related pressures), and contribute to the EU’s broader sustainable development goals.

Key SFDR Compliance Considerations

Compliance with the SFDR requires a proactive and systematic approach to sustainability that integrates ESG considerations into investment decision-making and reporting. This will look different for every firm, but some key considerations relevant to all financial participants include the following:

1. Understand and outline the scope of the SFDR

Financial market participants should understand the scope of the SFDR and how it applies to their business and products. They should also be aware of the different levels of disclosure required under the SFDR and what information is pertinent to each.

2. Develop a sustainability policy

FMPs should develop a sustainability policy that outlines how they integrate sustainability risks into their investment decisions and how they contribute to the EU’s sustainable development goals. The approach should be based on an analysis of environmental, social, and governance issues and their associated risks and opportunities, and should be aligned with the firm’s investment strategy.

3. Make data governance a priority

Financial market participants must collect data on a wide range of sustainability risks and opportunities to comply with the SFDR. This includes data on ESG factors that may require significant stakeholder engagement and information gathering in order to complete. Effective data governance is critical for meeting compliance requirements.

4. Assess and understand sustainability risks and opportunities

Financial market participants should assess sustainability risks and opportunities in their investment portfolios and take steps to address them. Examples may include divesting from high-risk assets, engaging with companies to improve their sustainability performance, or focusing on high-growth opportunities like decarbonization technologies.

5. Monitor and report on sustainability performance

Financial market participants should monitor their sustainability performance and report it to clients and regulators. Establishing a consistent system and cadence for reporting will ensure ongoing compliance with SFDR and associated disclosure requirements.

Additional Resources

Carbon Market Fundamentals Course

Transition Risks

ESG Score

See all ESG resources