December 5, 2022
Estimated reading time: 6 minutes
5 guiding principles for SFDR compliance
One month out from the full implementation of SFDR, in-scope financial market participants are running out of time to comply with the substantially vast and nuanced regulatory framework. Ben Richmond, CEO and Founder of CUBE, lays out five fundamental principles to not just survive but thrive under the new requirements.
Like it or not, we live in an age of cynicism. Intent is not enough, even outcome is not enough. Proof is king.
Nowhere is this more apparent than in the introduction of the Sustainable Finance Disclosure Regulation (SFDR).
Once upon a time, it was acceptable, even praised, to have a detailed mission statement setting out vague promises that lay somewhere between rudimentary corporate social responsibility (CSR) and more advanced environmental, social and governance (ESG) principles.
Today, investors and the wider public are increasingly sceptical, largely thanks to the rise of greenwashing. The EU, noting this, introduced SFDR to mandate detailed reporting on both the positive and adverse sustainability impacts of all financial market participants in scope. To meet the new requirements, fund managers require access to vast data pools, efficient technology, and a skilled compliance team. It’s a huge lift, and the compliance deadline is just one month away.
Yet despite the regulation being officially introduced in March 2021, and discussions being had around the need for it long before, many fund managers have either done little to prepare or have stagnated due to insufficient in-house resources and a lack of clarity on the standards.
Instead of burying their heads in the sand, in-scope market participants must act now. Here are five steps for getting it right come January.
1. Know what’s expected.
- Get to know SFDR inside and out. It sounds obvious, but the devil truly is in the detail when it comes to this regulation. Most mistakes being made aren’t malicious or fraudulent but human error and misunderstanding.
- Knowing what’s expected includes staying up to date with evolving and anticipated regulatory requirements, both in the EU and overseas jurisdictions.
- Of course, this can be a mammoth task. Regulatory technology such as CUBE’s RegTech exists that can be leveraged to track, capture, and map all relevant regulatory obligations, allowing firms to know what’s changed, what’s in force, and how it applies to their existing policy and control framework in an instant.
2. Invest in data.
- If proof is king, data is its right-hand man. Financial market participants to whom SFDR applies at an entity level must publish information on the policies used in the sustainability integration of investment products, an Adverse Sustainability Impacts Statement, and remuneration policies relating to sustainability objectives or ESG risks.
- Subsequently, at the product level, they must provide information on how sustainable investing risks are incorporated into the overall strategy, how and why an index or benchmark relates to ESG considerations, the results of testing, and the extent to which sustainability objectives have been met against regulatory technical standards.
- All of this requires immense pools of data to draw on, including industrial information, ESG reports, corporate relations data, and various third-party datasets. As such, in-scope market participants must ensure they have sufficient access to the right data at all times.
- Working with a RegTech that provides a ‘golden source’-style data repository can be a smart, cost-effective solution.
3. Automate reporting.
- SFDR demands ESG disclosures to be periodically and comprehensibly reported.
- While this information can be provided in the form of reports, excel spreadsheets or otherwise, they can be fragmented and rely on significant manual output, which can lead to indefensible gaps. This leaves firms scrambling around, trying to patch the holes and understand which piece goes where.
- This doesn’t look good to the regulator and can raise eyebrows, even where non-compliance has not occurred.
- Advanced RegTech tools will house this information under one roof, allowing businesses to pull defensible audit trails and watertight reports in an instant, rather than relying on third parties or adding to existing compliance workloads.
4. Invest in upskilling.
- Employees need to be upskilled to understand new regulatory requirements and work alongside emerging technologies.
- The compliance team in particular will need to evolve to interpret and implement the insights provided by new RegTech and require highly skilled people to apply human experience and industry knowledge to achieve faultless regulatory compliance.
- Given there is already a shortage of skilled compliance staff globally, market participants in the EU should make the most of their regulatory head start to commence recruitment and upskilling campaigns now, before demand gets even higher.
5. Acknowledge that ESG is the future.
- Climate change is the crisis of this generation – and likely the next. So legislation relating to ESG is here to stay.
- If anything, we will see much more of it over the coming years, with increasingly granular requirements. As such, financial market participants must ensure they are constantly evolving – not approaching requirements like SFDR as a “check-box exercise”, but embracing the spirit of them, and making sure they understand and are speaking to the true objective.
- An important part of this can be engaging with regulators, who ask frequently for public input, as well as monitoring for updates like Dear CEO letters, which may provide hints as to the types of things to expect on the regulatory agenda for the coming decade.
- To ease the compliance burden, CUBE’s RegTech automates the regulatory change process and replaces the task of manually scouring regulatory body websites. Automating the process mitigates compliance gaps and improves operational and commercial efficiencies. Regulatory intelligence can tell firms which regulations are relevant – reducing the risk of crippling enforcement fines and damaged reputations.
The future of SFDR
As a society, we have shifted away from immediately congratulating do-gooders, to reflex cynicism.
While this might seem like a loss, it signals a necessary shift away from black and white, good and bad mentality, that allows us to be much more critical and strategic in the ways we are impacting the world.
The downside of this is that firms must invest a lot more time and energy in the provability of their impact. The upside is that they can be sure of the effects they are having, and track them over time, allowing them to monitor and make meaningful adjustments for an exponentially greater positive impact.
It also means that they can prove all this to investors, giving them a much-needed competitive upper hand over those in foreign jurisdictions who are not yet at such an advanced stage of disclosure. The aggregate effect of this will play an important role in supporting the sustainable investment movement and moving the EU towards carbon neutrality by 2050.
But fund managers must act now. While the regulator has been relatively forgiving in the first phase of the rollout, January 1 means all systems are go. Moving forward, compliance crackdowns are only set to get harsher, in the EU and around the world. Ignorance is not an option.
Keep ahead of emerging SFDR regulations by speaking to CUBE.
Please note that an edited version of our blog was first published on Investment Week.