Ocorian urges asset managers to prepare for changes to the sustainable finance disclosure regulation (SFDR)

• Potential changes in the next SFDR update taking effect in 2025 include new product labels for ‘Article 8’ and ‘Article 9’ to provide more clarity between different products

Ocorian, a market leader in regulation and compliance services for funds, corporates, capital markets and private clients, is predicting changes to the Sustainable Finance Disclosure Regulation (SFDR) having analysed clues from the formal review of the regulation carried out by the European Commission in late 2023.

The EU Commission is expected to announce amendments later this year, but Ocorian is urging alternative asset managers to stay prepared and is highlighting what they can do to be one step ahead of more stringent ESG reporting which will likely take effect in 2025.

The five key changes anticipated by Ocorian in the next SFDR update:
 

1. Stronger disclosure requirements: The update is expected to require more granular information on sustainability factors considered in investment decisions, portfolio characteristics related to sustainability objectives, and the impact of investments
2. Taxonomy alignment: The EU Taxonomy for sustainable activities is expected to play a more prominent role in SFDR classification. Products labelled “Article 8” (promoting environmental or social characteristics) or “Article 9” (sustainable investment objective) will likely need to demonstrate a stronger alignment with the taxonomy
3. Sustainability risks: The concept of “sustainability risks” is likely to receive more focus. Disclosures might need to elaborate on how these risks are integrated into investment processes and risk management frameworks
4. Principle Adverse Sustainability Impacts: More emphasis might be placed on disclosures regarding Principle Adverse Sustainability Impacts (how investments negatively affect environmental or social goals). Reporting on engagement activities with companies on these issues could also be required.
5. Product labelling: The existing SFDR labels (Article 8 and 9) might be revised or supplemented with new categories to offer more clarity and comparability between different products. EU and UK regulators are consulting with each other, so it’s likely they will try to harmonise an approach to labelling across both regions, to help address the challenges faced by retail investors when trying to understand a financial product’s focus on sustainability

Ocorian also predicts that while there’s no indication of any significant change in scope on who the regulation applies to, they do expect many of the reporting requirements to be made broader. This means that regulation might even apply to financial market participants who don’t promote themselves as ‘sustainable’.

Another potential change to reporting standards involves standardising sustainability reporting across all financial products. This would mean some level of ESG reporting would be mandatory for all asset managers, regardless of whether their products fall under Article 6, 8, or 9. The minimum disclosures for all products would like cover sustainable risks, which would be considered applicable by default and must be reported, and justification for sustainability claims, which means that any sustainability claims made during marketing would require clear justification.

Other changes could include the Principal Adverse Impact (PAI) statements, following the SFDR consultations. If changes are adopted, there will be new reporting templates for entities required to report under SFDR. This means entities choosing to report PAIs would need to consider and report on a wider range of potential impacts.

Ocorian predicts these amendments to include:
 

• Expanding the list of social impact indicators considered in PAI assessments
• Refining the way PAI disclosers are presented
• Introducing requirements to disclose greenhouse gas (GHG) emission reduction targets
• Strengthening disclosures on compliance with the ‘Do No Significant Harm’ (DNSH) principle
• Revising the rules for reporting on Multi-Option Products (MOPs)

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.”

Alongside its fund administration services, Ocorian provides ESG reporting through its partnership with Treety, ESG reporting specialists in the alternative investment space. Ocorian has a team of ESG experts in its regulatory and compliance division to help clients assess the impact of SFDR on their business and ensure they are well placed to implement each of the amendments when they come into force.