Ocorian, a leading provider of regulation and compliance services for funds, corporates, capital markets, and private clients, has forecast significant changes to the Sustainable Finance Disclosure Regulation (SFDR) following a recent review by the European Commission.
With the EU Commission expected to announce amendments later this year, Ocorian is urging alternative asset managers to stay prepared for more stringent Environmental, Social, and Governance (ESG) reporting requirements, likely to come into effect in 2025.
In analysing the clues from the Commission’s late-2023 review, Ocorian has identified five key areas where changes are expected:
- Stronger Disclosure Requirements: The revised SFDR is likely to demand more detailed disclosures on sustainability factors considered in investment decisions, the sustainability characteristics of portfolios, and the broader impact of investments. This will push asset managers to provide more granular information, enhancing transparency for investors.
- Taxonomy Alignment: The EU Taxonomy for sustainable activities is anticipated to play a more prominent role in SFDR classification. Products labelled under “Article 8” (which promotes environmental or social characteristics) and “Article 9” (which has a sustainable investment objective) will likely need to demonstrate stronger alignment with the taxonomy, ensuring that investments meet stricter sustainability criteria.
- Increased Focus on Sustainability Risks: The concept of “sustainability risks” is expected to gain more attention. Disclosures might need to include detailed explanations of how these risks are integrated into investment processes and risk management frameworks, ensuring that asset managers account for potential ESG-related challenges in their decision-making.
- Enhanced Reporting on Principal Adverse Sustainability Impacts: Ocorian anticipates a greater emphasis on disclosures related to Principal Adverse Sustainability Impacts, which address how investments negatively affect environmental or social goals. This could include mandatory reporting on engagement activities with companies to address these issues.
- Revised Product Labelling: The existing SFDR labels (Article 8 and 9) might be revised or supplemented with new categories, aimed at providing more clarity and comparability between different products. With EU and UK regulators consulting on harmonising their approaches, the changes could help retail investors better understand a financial product’s sustainability focus.
Ocorian also suggests that the scope of the SFDR could be broadened, potentially applying to financial market participants who do not currently market themselves as ‘sustainable’. Additionally, standardising sustainability reporting across all financial products may become mandatory, meaning that some level of ESG reporting would be required for all asset managers, regardless of whether their products fall under Article 6, 8, or 9.
One of the most significant changes could involve the introduction of new reporting templates for entities required to report under SFDR. This would include expanding the list of social impact indicators considered in Principal Adverse Impact (PAI) assessments, refining PAI disclosures, and introducing requirements to disclose greenhouse gas (GHG) emission reduction targets. Strengthening compliance with the ‘Do No Significant Harm’ (DNSH) principle and revising the rules for reporting on Multi-Option Products (MOPs) are also anticipated.
Hatim Baheranwala, Cofounder and CEO of Treety, Ocorian’s ESG reporting partner said: “The aim of the original Sustainable Finance Disclosure Regulation, implemented by the European Commission in 2021 was to provide retail investors and Limited Partners such as pension funds clarity and transparency on the sustainability characteristics of investment funds marketed to them – thereby tackling greenwashing.
“The chosen approach was to define a set of expected disclosures and reports, and not undertake any formal labelling. This has unfortunately backfired during implementation, since the reporting categories such as Article 6, 8 & 9 have emerged as de facto labels. Additionally, the decision of allowing investment firms to establish their own definition for terms such as “sustainable investments” has led to even more confusion in the market, where differing firms have developed very diverse definitions for these terms.
“It is therefore a welcome sign that the EU is undertaking this review, and we expect the forthcoming amendments to the structure of the SFDR and its related technical standards to be announced soon. We are also urging asset managers to stay one step ahead and be prepared – while the regime is being improved and simplified, by entering into this review the EU has clearly signalled that its aim is to eliminate loopholes and ensure standardised sustainability reporting across the entire market.
“We recommend that all alternative asset managers start by reviewing their current ESG and sustainability reporting processes and ensure that they are taking steps to ensure completeness, credibility and efficiency in their reporting flows – just like they do for their financial disclosures.”
Baheranwala added that the forthcoming amendments are a welcome step towards standardised sustainability reporting across the market, and urged asset managers to proactively review their current ESG reporting processes. He emphasised the importance of ensuring completeness, credibility, and efficiency in these processes, akin to financial disclosures.
Ocorian, through its partnership with Treety, offers comprehensive ESG reporting services. Their team of experts is poised to assist clients in navigating the upcoming SFDR amendments, ensuring they are well-prepared for the changes on the horizon.
