Risk & Compliance News

Impact of the SFDR for financial firms not (explicitly) focusing on sustainability

Date:December 20, 2022

In recent months, we have published several blogs on the Sustainable Finance Disclosure Regulation (SFDR). In particular, we have focused on the rules that will apply to ‘sustainable’ products and financial firms that offer them. But what about if your company does not explicitly deal with sustainability and does not offer sustainable financial products? For example, because that does not fit your target group or (investment) strategy. Because you believe that sustainability plays little or no role in your products/services? Or because your priorities are simply different?

Even in this case, obligations of the SFDR apply to your company and you will have to take action. Although the SFDR will then have slightly less far-reaching consequences for you, there are still a number of provisions from the SFDR that you need to implement.

In the words of the AFM: “The AFM emphasises that your company must comply with the Amendments (such as the SFDR, ed.) regardless of existing sustainability views or preferences of customers.

The ‘grey’ company

For readability, we refer to firms that do not explicitly focus on sustainability as ‘grey’ firms in this article. Within the SFDR, you can be grey in two areas:

  • In choosing whether or not to include the negative sustainability impacts of your investments (such as the environment or human rights) in your investment decisions; and
  • In the products you offer (you can offer grey and/or ‘green’ products).

In principle, these components are separate. So, for instance, as a company you can pay attention to the negative consequences of investments on sustainability (and therefore be green on that aspect), but at the same time not offer products that qualify as green (and therefore be grey on that aspect). In this article, we assume the company is grey on both parts. That is, therefore, a company that:

  • when investing, does not pay attention to the possible negative impact of the investments on sustainability; and
  • only offers grey products.

Please note that the products must actually be grey in terms of features and expressions; you Amy not designare products as ‘grey’ and at the same time state in, for example, product documentatie or investment policy that you include sustainability factors.

Obligations for the grey company

As already followed from what the AFM said, grey firms must also comply with the SFDR. This means that from 10 March 2021, these firms

  • must explain how they integrate sustainability risks into investment decisions;
  • must state that they do not consider any negative impact on sustainability factors when investing;
  • must comment on the financial impact of sustainability risks on a product-by-product basis:
    if the company does not consider such risks relevant, the company must explicitly state and substantiate this;
    if the company does consider such risks relevant, the company must describe the expected effects of the sustainability risks on the value of the investments;
  • must explain how their remuneration policy is consistent with how sustainability risks are integrated into investment decisions.

This sounds – especially if you are not at home in the terminologie of the SFDR – quite complicaties. What is meant by sustainability risk? And how do you correctly make it clear that you do not consider negative impacts on sustainability factors when investing?

Integrating sustainability risks

The SFDR provides a rather lengthy definition of a sustainability risk. It defines it as a sustainability event (e.g. a flood, storm, or human rights controversy) that, when it occurs, could lead to a material adverse effect on the value of investments. What exactly should you imagine this to be?

Damage from sustainability events can affect the value of investments. Think of shares in Volkswagen, the company that saw as much as €27 billion in stock market value evaporate as a result of the emissions scandal (“diesel-gate”). Or investments in so-called stranded assets: assets that lose their value, for instance because they are no longer usable due to climate legislation. In short: sustainability events can pose a risk to the value of investments, and the term ‘sustainability risk’ is used to describe this risk.

The SFDR stipulates that – regardless of whether you want to engage in sustainability – you should integrate such risks into your investment decision-making process. This means, firstly, that you should consider in your investment decision-making process whether there is a material risk that the value of an investment could fall as a result of a sustainability event. How do you take this risk into account when selecting investments? You should indicate on your website how you have set up this process.

It may be that it follows from your analysis that sustainability risks are not relevant to your current investments. In that case, you should indicate this clearly and with reasons in the pre-contractual information (e.g. the prospectus or the information memorandum).

Where sustainability risks may well be relevant to the value of the investments, you should assess what the impact of the risks may be on the return of the investments, and include this in the pre-contractual information.

This information will help customers know how you factor the financial risks they face (as a result of sustainability events) into the investment process and what the impact may be on the value of the investment.

Not paying attention to adverse sustainability impacts

You are free not to consider the adverse sustainability impacts of investments when investing. So you may – if you wish – feel free to invest in fossil fuels, palm oil plantations, mining companies or the fast fashion industry. You are not obliged to consider the consequences of these and other investments on sustainability factors.

You may have several reasons for this. It could be that you want to focus primarily on (short-term) financial returns for your clients, and that sustainability is secondary to that ambition. Another reason could be that you believe there is insufficient sustainability data available, or that you have insufficient capacity to analyse this data.

In this case, however, you are obliged to clearly communicate to your customers that you do not take this into account. This must be done by means of a so-called No consideration of principal adverse impacts statement. This is a statement in which you explicitly state that you do not take the negative effects of investments on sustainability factors into account and why you do not do so. Again, you must put the statement both on the website and in the pre-contractual information.

Remuneration policy

Above, we already told you that you should integrate sustainability risks – regardless of whether you want to engage in sustainability – into your investment decision-making process, and explain on your website how you do this. With that, however, you are not there yet.

You will need to look at your remuneration policy and check whether it is in line with internal practices on integrating sustainability risks. For example, does the policy contain incentives that might encourage employees to disregard any sustainability risks, whereas such risks should (according to internal practice) be included in the valuation of potential investments?

Relevant elements in the remuneration policy to look at include: qualitative kpi’s for staff, deferred payment of variable remuneration, possible reduction of variable remuneration in case of improper behaviour or claw-back possibilities.

Consistency of information

We see that several organisations (prefer) to label themselves as grey. The SFDR does not hinder this. However, be careful here that you are not (unintentionally) guilty of greenwashing. If you are a grey company with grey products, you may not market yourself as green. So you should not suggest that you include sustainability aspects in your investments or offer green products. So it is vital that you do a check on all your mandatory and non-mandatory disclosures (website, product brochures, prospectuses, etc.). Are you not pretending to be greener or greyer anywhere than you actually are?

In conclusion

Although the SFDR rules for grey companies are lighter than for (slightly) green companies, there is also a lot of work to be done for grey companies. Both internally and externally, you will need to assess what adjustments and analysis need to be done before 10 March 2021. So this applies even if you do not have any sustainability ambitions. Do you have questions about the standards described in this article, or would you like support in implementing these obligations? If so, please feel free to contact us.