The EU’s Sustainable Finance Disclosure Regulation (SFDR) requires asset managers to classify their funds as either an article 6, 8 or 9 fund depending on their level of sustainability – but what does this mean, exactly?
In this blog, we have gathered everything you need to know about articles 6, 8 and 9. What articles are you affected by? How do you comply? And what is needed for a fund to be classified ESG? Let’s have a look:
What is the SFDR?
SFDR is a part of the EU’s Financing Sustainable Growth Action Plan and was established to reorientate capital flow towards sustainable finance. SFDR requires asset managers and other financial market participants to provide transparency on sustainability and imposes mandatory ESG disclosure obligations.
According to the SFDR’s classification system, a fund will either be classified as an article 6,8 or 9 fund – depending on their characteristics and level of sustainability:
Article 6: Funds without a sustainability scope
Article 8: Funds that promote environmental or social characteristics (light green)
Article 9: Funds that have sustainable investment as their objective (dark green)
In essence, article 6 requires asset managers to disclose the integration of sustainability risks in their funds– regardless if the fund is promoted as ESG or not. Investments promoted as ESG, however, are required to classify as being either an article 8 or 9 fund, depending on which classification requirements their financial products meet. Many are referring to article 8 funds as “light green” and article 9 as “dark green” since the requirements are higher to be labeled an article 9 fund. Just to make it extra crisp, let’s dive even deeper into what the different articles imply and what you have to do to meet the requirements.
What is SFDR article 6?
Article 6: Transparency of the integration of sustainability risks requires the following:
“Financial market participants shall include descriptions of the following in pre-contractual disclosures:
The manner in which sustainability risks are integrated into their investment decisions; and
The results of the assessment of the likely impacts of sustainability risks on the returns of the financial products they make available.
Where financial market participants deem sustainability risks not to be relevant, the descriptions referred to in the first subparagraph shall include a clear and concise explanation of the reasons therefore.”
This means that provisions for the above disclosures must be included already in the fund’s prospectus. If sustainability risks are considered to be relevant for a fund, assets managers are required to:
Declare that they have integrated sustainability risks into the investments decisions;
Develop a process to assess and identify the most significant risks
Have a disclosure policy in place that mitigate and acts on risks;
Describe how it will be achieved and track the implementation and results
And remember, funds don’t have to be classified as ESG or Green for this article to apply, and if a fund deems sustainability risks not to be relevant, it must clearly be stated and rationalized according to the article.
What is SFDR article 8?
For a fund to comply with article 8: Transparency of the promotion of environmental or social characteristics in pre‐contractual disclosures requires the following:
“Where a financial product promotes, among other characteristics, environmental or social characteristics, or a combination of those characteristics, provided that the companies in which the investments are made follow good governance practices, the information to be disclosed pursuant to article 6 shall include the following:
Information on how those characteristics are met;
If an index has been designated as a reference benchmark, information on whether and how this index is consistent with those characteristics.”
Financial market participants shall include in the information to be disclosed pursuant to article 6(1) and (3) an indication of where the methodology used for the calculation of the index referred to in paragraph 1 of this article is to be found.
So, article 8 applies to funds promoting environmental and social objectives and which take more into account than just sustainability risks as required by article 6.
However, article 8 funds don’t have ESG objectives or core objectives – as required for becoming labeled an article 9 fund.
What is SFDR article 9?
For a fund to comply with article 9: Transparency of sustainable investments in pre‐contractual disclosures requires the following:
“Where a financial product has sustainable investment as its objective and an index has been designated as a reference benchmark, the information to be disclosed pursuant to article 6 shall be accompanied by the following:
Information on how the designated index is aligned with that objective;
An explanation as to why and how the designated index aligned with that objective differs from a broad market index.”
Compared to article 8 funds, which should promote environmental or social characteristics and have good governance practices, article 9 funds should make a positive impact on society or the environment through sustainable investment and have a non-financial objective at the core of their offering. Both article 8 and article 9 funds will be considered ESG aligned, only that the latter one is for even further forerunners in sustainability, hence the light green and dark green reference.
How the EU Taxonomy links to SFDR
The EU Taxonomy is a classification system for environmentally sustainable economic activities and is integrated into the SFDR – specifically article 8 or 9 as these cover environmentally and or socially sustainable investments.
For both articles, a fund needs to disclose information about the proportion of Taxonomy alignment. Alignment should be expressed as percentage in turnover, capex and opex and also separated per transitional and enabling activities.
Integrate your ESG risk analysis in Worldfavor
If you need help to get going with your SFDR reporting and follow-up process, then we got the solution for you! Worldfavor’s Sustainable Investment is a finance solution that allows you to collect, aggregate and analyze all needed data in order to comply with the SFDR and report on time. Whether you’re directly or indirectly affected by the SFDR framework, Worldfavor’s experts can help you to comply with the reporting and disclosure requirements.