In this episode of Sustainable Intelligence, Laura Callaghan, Head of EMEA Services at Novata, discusses the Sustainable Finance Disclosure Regulation (SFDR). The SFDR is a critical framework introduced by the European Commission in 2021. Laura connects the SFDR to broader EU initiatives like the Corporate Sustainability Reporting Directive (CSRD) and EU taxonomy, emphasizing its role in driving greener investments. Plus, we discuss practical tips for firms new to SFDR, highlighting essential disclosures and methodologies to meet regulatory requirements.
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Sustainable Intelligence is an interview series from Novata that explores ESG and sustainability in the private markets. From carbon accounting to using data to create value, the series dives into the challenges and opportunities facing private market investors and company leaders as their integrate ESG across the business and respond to regulatory requirements. Each episode centers authentic dialogue, highlighting experts at the forefront of advancing ESG data collection and driving meaningful progress in the sustainability landscape. Listen to more episodes.
Conversation with Laura Callaghan (Transcript)
Ella Williamson: Welcome to Sustainable Intelligence, where we discuss all things ESG and sustainability for the private markets, brought to you by Novata. I’m Ella Williamson, and I’m thrilled to be your host today. We’re joined by Laura Callaghan, EMEA Services Lead at Novata. Laura is a Chartered Environmentalist and Certified Climate Risk and Sustainability Professional.
Today, we will explore the complexities of SFDR and provide you with the knowledge you need to confidently navigate this regulatory terrain. Laura, first off, what is SFDR and who does it apply to?
Laura Callaghan: So the SFDR stands for the Sustainable Finance Disclosure Regulation, and it’s a regulation that was introduced back in 2021 by the European Commission. It introduces mandatory information on a broad range of environmental, social governance topics and metrics, and these all need to be disclosed in addition to broader information about how things like sustainability risks are incorporated into investment decision making processes and other processes.
Parts of a firm’s business strategy. It’s directly impacting financial market participants and financial advisors that may be in the EU. It’s also impacting financial market participants that may be outside of the EU, but they have EU shareholders. And it’s also impacting financial market participants and advisors that market or manage financial products. So by financial products here, I’m meaning things like funds in the EU market. And some examples of this last category include things like alternative investment funds or insurance based investment products, pension products, workplace products, etc.
Ella: Fascinating. It’s clear that it’s all about giving investors the information that they really need to make more sustainable choices. Could I ask you to explain the difference between Article 6, Article 8, and Article 9?
Laura: Yes, absolutely. So you hit the nail on the head when you said that it’s really aiming to create a framework that requires financial market participants to disclose information on sustainability ambitions. It’s also seeking to create a level playing field for investors to compare sustainability related information.
So with that in mind, the differences between article six, eight and nine really depend on the disclosures, which a firm or a fund has to make. The easiest way to think about this is that the SFDR makes a distinction and imposes different disclosure obligations for Article 9 products. In a nutshell, the biggest difference between these is whether a financial product, like a fund, promotes sustainable characteristics, or whether it has a sustainable investment objective. By promoting sustainable characteristics here I’m meaning things like environmental or social characteristics. Some common ones that are often included here are things like having a decarbonisation strategy for the fund or having specific metrics like diversity, equity and inclusion pieces to evidence that they’re the characteristics that the fund is promoting.
Whereas from an Article 9 perspective, it’s all about having a core purpose, a core objective of the fund being related to sustainability. And that means that the fund either has a sustainable investment as its objective. So this is something that actively contributes to environmental or social objectives and things like human capital or economically or socially disadvantaged communities. They also have to prove that they don’t do any significant harm to the objectives and that the companies within the fund follow good governance practices. And then the second part to an Article 9 product is if it has a carbon reduction strategy or has a reduction in carbon emissions as its objective as well. So it’s really about what are the core differences in classifying your fund. Article 8 is promoting. Article 9 is objective. And then from an Article 6 perspective. That is where there is no consideration of ESG at all.
Ella: Thanks for breaking that down so clearly, Laura. It makes sense that these distinctions help investors understand the sustainability profiles of different financial products and really helps them make more informed decisions and choices. So how does the SFDR link to other frameworks and other regulations?
Laura: Great question. So the SFDR is part of something broader that the EU have put into place called the Sustainable Finance Framework, and that’s something that is there to really help the European Commission and Europe as a whole meet that goal. Things like its net zero carbon goals, and to really promote and move capital into greener investments and greener activities. So with all of these commitments that Europe has made, they’ve started to build in various different regulations to help them meet these targets. So the SFDR is all about investors and how they are moving capital into greener investments and being transparent about what proportion of their products are sustainable. There are other elements to the European Sustainable Finance Framework, such as the CSRD, which stands for Corporate Sustainability Reporting Directive, and that’s applied to things like companies. So from an SFDR perspective, they have to gather a lot of the information from either their assets or their investee companies. But it’s really difficult to get that information when companies don’t have the processes in place themselves to collect that data.
So the CSRD is all about Private and public European companies, as well as non EU companies with a substantial presence in Europe, collecting this information that will also feed into the SFDR and their own disclosures. There are other things like the EU taxonomy, which is a classification system of economic activities that are specifically contributing to environmental objectives. There’s a whole host of different predefined criteria, but again, it’s very similar. To state things like not causing significant harm to environmental topics like biodiversity or circular economy, and that’s a framework investors can use to identify and ascertain what proportion of their fund is deemed to be sustainable. And then lastly, one of the newest regulations, or one of the newest pieces to this puzzle, is what’s called the Corporate Sustainability Due Diligence Directive, or the CSDDD, that’s again linked more to corporates, and it’s about providing corporates with a framework and a way for them to proceed, better ascertain, identify, assess, mitigate and prevent human rights issues, building things like transition plans to support their net zero carbon goals. And so the best way to think about the SFDR is that it’s part of this much broader ecosystem of European regulations. Yeah.
Ella: So a lot of acronyms there, but I love the way that you’ve described that as SFDR. being part of a bigger ecosystem and almost acting as the glue to help businesses transition towards a greener economy. Do you have any top tips for firms just starting out with SFDR?
Laura: I would say definitely worth doing some reading on what’s required from an SFDR perspective. We typically find most people or most businesses that are new to SFDR are those that may not necessarily be based in Europe, but they’re looking for European investment. And so if they do gain European investment from EU shareholders, they would then fall into the scope of the SFDR. So rather than diving into it head first and not actually really figuring out what needs to be done, I’d highly recommend understanding what is needed and what the disclosures are. The first one is pre contractual disclosure and there is a predefined template that firms must use to complete this. It’s essentially establishing what article classification the fund is, what those characteristics are that it’s either promoting or what sustainable investments it’s making. And it’s really setting the tone and defining what the fund is all about, referencing any methodology that needs to be included as well.
You then have the website disclosure. There’s no template for this, but there are certain things that you have to disclose. So, for example, figuring out and identifying what the investment strategy looks like, what methodologies are used to monitor the promotion of characteristics or the sustainable investment objective, things like how ESG is incorporated into your due diligence process, any engagement policies, and also any limitations to methodologies and data collection.
The other aspect is an annual disclosure, which is called the periodic disclosure, and this is essentially something that helps to retrospectively look back at the previous year to say how the fund has performed in comparison with the pre contractual disclosure information that you’ve said. So, what did you say you were going to promote? How did you say you were going to measure it and have you actually achieved this? And then another annual disclosure in the fourth one that I’ll mention is the Principal Adverse Impact Statement, otherwise known as the PAI statement. PAI relates to negative impacts on sustainability, both at an entity and a product level.
And so the easiest way to think about this is from an entity perspective, you have to include all funds within this statement. So you have certain mandatory pieces of information relating to things like scope 3 carbon emissions or human rights issues and that gets aggregated across all funds to create a PAI statement. And that’s where the metric piece really comes into play.
Ella: So a lot of disclosures to think about there. Thank you for breaking that down. So clearly, if we all follow your advice, we’ll be sailing through SFDR requirements in no time. Laura, thank you so much for all your insights today. It was fascinating having you on.
Until next time, let’s keep building sustainable intelligence together. Find out more at novata.com.
