The Sustainable Finance Disclosure Regulation (#SFDR) requires specific entity and product-level disclosures from firms.
Financial Market Participants and Financial Advisors need to:
Demonstrate how they address negative sustainability factors, such as environmental and social issues, within their investment products and processes.
The two key factors that you must consider:
A. Sustainability Risks
B. Principle Adverse Impacts (also known as #PAIs).
A.) Sustainability risks refer to environmental, social, or governance events or conditions, such as climate change, which could cause an actual or a potential material negative impact on the value of an investment. Examples: Environmental sustainability risks may include climate change, carbon emissions, air pollution, rising sea levels or coastal flooding or wildfires. Social sustainability risks may include human rights violations, human trafficking, child labour or gender discrimination; and Governance sustainability risks may include a lack of diversity at the board or governing body level, infringement or curtailment of rights of shareholders, health and safety concerns for the workforce or poor safeguards on personal data or IT security.
B.) Principle Adverse Impacts (PAIs) can be described as the negative sustainability factors that investments, decisions, or advice may have. Examples include investing in a company that significantly contributes to carbon dioxide emissions or has poor water, waste, or land management practices.
What does sustainability mean for these purposes?
#1. Sustainable investment:
In summary, this is an investment in economic activity which:
• contributes either to an environmental objective or a social objective
• does not significantly harm any environmental or social objectives and
• the investee company follows good governance practices.
#2. Sustainability risk:
This is an environmental, social or governance event or condition that, if it occurs, could cause a material negative impact on the value of an investment.
#3. Sustainability factors:
This means environmental, social and employee matters, respect for human rights, anti-corruption and anti-bribery matters.
The most challenging aspect of the SFDR is probably the principal adverse impacts (or PAI) regime. Principle Adverse Impact indicators are a set of mandatory indicators and metrics that aim to show financial market participants how certain investments pose sustainability risks. Under these new rules, fund managers, financial advisors and other financial institutions will need to collect ESG data and disclose any sustainability risks associated with their investments and financial products.
(ESG data is an abbreviation of Environmental, Social and Governance metrics.)