The SFDR is an EU regulation that comes into effect on 10 March 2021 and introduces requirements to address environmental, social and governance (ESG) concerns.
It will apply directly to relevant firms in EU member states, but the assumption in the market was that it would also be adopted into UK law. However, since SFDR becomes effective after the end of the Brexit transitional period and has not been part of the UK’s onshoring program, it became clear towards the end of 2020 that it will not be part of UK law.
Overview of SFDR
The SFDR requires financial market participants (e.g. MiFID investment managers, alternative investment fund managers, UCITS management companies, in summary asset managers) and financial advisers to make policy decisions about how sustainability is integrated into their business. It also requires firms to make certain disclosures on their websites and to clients and investors on a pre-contractual and periodic basis about financial products (e.g. funds).
The disclosures relate to the integration of sustainability risks in the asset manager’s investment process and the consideration of adverse impact that investments may have on sustainability factors.
Sustainability risk is defined in SFDR as an ESG event or condition that, if it occurs, could cause an actual or a potential material negative impact on the value of the investment.
Sustainability factors are defined in SFDR as environmental, social and employee matters, human rights, anti-corruption and anti-bribery matters.
However, firms are permitted to make a decision on whether they will comply with or explain the reasons why they don’t consider certain elements of the SFDR. There are additional requirements for firms that either promote sustainable investment products or offer financial products with sustainable investment as an objective.
The EU also proposed regulatory technical standards under SFDR detailing the proposed form and content of the disclosures, but these have been delayed and are expected to apply to EU firms from 2022.
Could SFDR Still Apply to UK Firms?
Even though SFDR has not been adopted into UK law post-Brexit, there are a number of ways in which SFDR could be relevant for UK firms, either as a requirement or on a practical level. We summarize below some of the circumstances under which SFDR could become applicable to UK firms:
- A UK fund manager who markets funds into the EU under national private placement regimes (NPPRs).
- For instance, a UK AIFM is now a non-EU (or third country) AIFM and if it is registered to market into an EU Member State under NPPRs, it will be subject to the SFDR.
- A UK fund manager who acts as the delegated investment manager to an EU firm which is subject to SFDR.
- The EU firm may wish to push down the obligations to comply with the SFDR to the UK firm.
- A UK firm comes under client or investor pressure to comply with SFDR and therefore decides to opt in.
- Firms may take a commercial decision in this case to comply with SFDR.
- A UK firm is part of a global group that has EU-based entities within its group and therefore decides to implement SFDR as a global standard.
- The group may decide to impose SFDR as the highest common denominator standard.
- A UK firm may see SFDR as a gold standard for ESG disclosure requirements and therefore decides to adopt it on a voluntary basis.
- Some UK firms may adopt SFDR to gain a competitive advantage.
- A UK firm operates funds with an EU structure and is responsible for compliance with SFDR.
- Although it is an EU firm that is subject to SFDR in relation to the fund, in practice the UK firm may have to take the lead on SFDR implementation as an operator.
Considerations for UK Firms to Assess Whether SFDR Applies
- Check whether you are planning to market any funds into the EU after 10 March 2021 under NPPRs
- Are you operating or sponsoring any EU fund structures? If so, you should liaise with the fund Board and any third parties involved about the responsibilities for SFDR.
- If you are providing fund management or advisory services to EU clients that are financial market participants, you should anticipate having SFDR requirements imposed on you.
- Firms that are part of groups containing an EU firm should review group policies and decide whether to impose SFDR to the UK firm on a voluntary basis.
- Discuss with your investor or client’s relations teams about whether there has been any pressure to comply with SFDR from clients or investors
- Assess whether you see any commercial or competitive advantage in complying with SFDR on a voluntary basis.
The UK’s approach to Sustainable Investment Regulation
In November 2020, UK Chancellor Rishi Sunak outlined the UK’s roadmap to developing and implementing more robust environmental disclosure standards on a different timescale to the EU’s SFDR. Given the urgency of the climate threat, a voluntary approach to climate related financial disclosures is not considered sufficient. The UK will therefore be the first country in the world to make disclosures that are aligned with the Task Force on Climate related Financial Disclosures (TCFD) fully mandatory by 2025, going beyond the “comply or explain” approach adopted under SFDR.
The FCA intends to consult on these new requirements in the first half of 2021 and aims to finalize the rules by the end of 2021. Implementation is likely to be phased, starting with the largest firms in 2022 and introducing requirements for smaller firms in 2023.
How Can We Help?
We have significant experience working on SFDR and will be closely following the FCA’s consultation and policy statement on its new disclosure rules. We are developing a toolkit for Sustainable Finance and we would be very happy to assist firms through this process. Please contact us if you wish to discuss further.