Navigating the SEC’s climate-related disclosure rules: A guide for businesses

Written by
Zeke Sexauer
Published on
March 8, 2024

With the Sustainable Finance Disclosure Regulation (SFDR) in effect for financial market participants in the European Union, any financial entity or stakeholder located or doing business in the European Union is required to report high level sustainability metrics to the financial governing bodies of their respective member states.

This article covers everything about SFDR that global financial stakeholders and EU financial market participants need to know. We cover SFDR from high level concepts and summaries of specific articles in the legislation with detailed examples of SFDR reports, SFDR reporting templates, and easy software for SFDR reporting and SFDR compliance.

What is SFDR?

The Sustainable Finance Disclosure Regulation (SFDR) is a European Union regulation that aims to promote sustainable decision making for financial market participants in EU markets. SFDR repeals and replaces the Non-Financial Reporting Directive (NFRD), and is closely tied to the Corporate Sustainability Reporting Directive (CSRD), which updates sustainability reporting requirements for all business entities participating in the EU.

The main objective of SFDR is environmental, social, and governance (ESG) transparency. SFDR does not compel any business-altering action on the part of financial market participants. SFDR only requires transparent ESG reporting under the SFDR guidelines (disclosure requirements for affected organizations are covered in detail below). SFDR reports must be kept up to date and publicly viewable on participants’ websites, and no marketing materials may contradict information provided in SFDR reports.

Why SFDR Matters

SFDR is a part of larger efforts by the European Union to bring ESG transparency to markets so that stakeholders, investors, customers, and governing bodies can have insight into market behavior beyond financial disclosures, and encourage market participants to make long-term sustainable decisions.

Climate and resource sustainability is a large focus of the SFDR legislation, but it also mandates disclosures on social and governance sustainability practices.

Many other governments and regulatory bodies around the world are introducing regulations similar to SFDR in their own jurisdictions, so laying the foundation for reporting ESG impacts and considerations is a good idea for businesses everywhere, even outside the EU.

The general theory behind the global ESG effort and corresponding regulations is that ESG factors have long-term consequences for the health and stability of our economy, and that markets will have healthier long-term outcomes if market actors include ESG transparency in their decision making processes.

The hope is that through SFDR and other ESG related reporting mandates, businesses will realize the benefit of including ESG considerations and voluntarily invest in sustainable initiatives in the interest of their own longevity. The reports will also give governments and researchers more granular data to investigate the impacts of financial market participants on sustainability over the long term.

Who does the SFDR apply to?

The SFDR applies to any organizations handling money, insurance, investments, retirement products, pension products, or venture capital in European markets — regardless of whether they are headquartered primarily in a European jurisdiction. There are two main classifications for organizations required to report under SFDR:

  1. Financial Market Participants. Organizations that offer or manage financial products qualify as financial market participants. The definition of financial market participant is intended to cast a wide net, and includes any organization that deals in credit, investment portfolios, insurance, pensions, alternative funds, venture capital funds, and any other institution that offers financial products, goods, or services.
  2. Financial Advisors. Organizations that provide financial advice or recommendations qualify as financial advisors under SFDR. Financial advisors are required to publish SFDR reports even if they do not directly manage funds, pensions, insurance, credit, etc.

What are the disclosure requirements for SFDR?

  • Principal adverse impacts (PAI): SFDR disclosures require financial market participants and advisors to report how their operations affect sustainability and what actions they take or plan to take to mitigate those affects.
  • Sustainability risks: SFDR disclosures also allow organizations the opportunity to report how sustainability risks outside their direct control affect their operations.

What are the SFDR levels?

SFDR reporting has two levels of analysis, “Entity” and “Product”. Financial market participants that employ more than 500 employees in a calendar year are required to disclose entity and product level sustainability practices. Organizations with fewer than 500 employees may still be required to report product level ESG practices according to SFDR legislation.

Entity-level disclosures

The goal of entity-level disclosures is to paint the fullest possible picture of the sustainability impact of the organization as a whole and its decision making processes that factor ESG.

Entity-level SFDR reports require financial market participants to disclose 3 things:

  1. How principal adverse impacts are factored into decisions and operations at an organizational level,
  2. A description of any existing identified adverse impacts and sustainability risks, and
  3. Any actions taken or planned to mitigate the disclosed impacts.

Wherever adverse impacts are intentionally not considered, organizations are required to report why they are not considered, and whether and when they intend to consider the relevant impacts. It’s easy to miss relevant data in entity level reports, so using a robust SFDR reporting tool is highly recommended.

Entity- level reports are required by all financial market participants in the EU with greater than 500 employees in a calendar year. Reports must be published on the reporting organizations’ websites. Some EU jurisdictions require direct notification of publication or updates to SFDR reports. To determine the specific SFDR reporting requirements in the EU member state in which your organization files its financial disclosures, consult the website of the relevant financial supervisory authority.

An ideal SFDR disclosure will include relevant information as granular as the transportation and energy usage of employees all the way up to broad investment decision making policies that factor sustainability.

Product-level disclosures

Product-level SFDR reports require disclosures about financial products, such as specific mutual funds, pensions funds, or an insurance-based investment product. Product- level SFDR reports concern the same adverse sustainability impact considerations as entity level reports, but the breadth of the reporting is consolidated only to the product, and not the organization as a whole.

Organizations with fewer than 500 employees that offer financial products are often still required to compile and submit SFDR reports regarding those offerings, though they are exempt from entity-level reports. Product level SFDR reports require disclosure of activities and types of financial products offered, managed, or advised on, and whether adverse sustainability impacts are considered. Similar to entity level reports, if organizations do not consider adverse sustainability impacts for a given product, they are required to offer information explaining why they do not consider sustainability factors and whether and when they intend to consider those factors.

What are the SFDR Reporting Classifications?

Article 6

Article 6 of the SFDR legislation dictates how the integration of sustainability risks are to be reported by specific organization type and size. Paragraphs 1 and 2 of Article 6 of SFDR requires pre-contractual disclosure of the manner in which sustainability risks are considered and integrated into investment decisions or advice, and assessments of the results of those decisions on financial products. Where financial market participants or advisers deem sustainability risks irrelevant, they are required to provide explanations for that conclusion.

Paragraph 3 of Article 6 of SFDR is more complicated. It refers to other existing EU legislation to describe the manner of the disclosures required by paragraphs 1 and 2. Below is a table of the qualified organization types and the respective EU directives that detail their reporting requirements.

Organization typeReferred EU directiveAIFMsDirective 2011/61/EU – Article 23Insurance UndertakingsDirective 2009/138/EC – Article 185, or Directive (EU) 2016/97 – Article 29IORPsDirective (EU) 2016/2341 – Article 41Venture Capital Fund ManagersRegulation (EU) No 345/2013 – Article 13Social Entrepreneurship FundsRegulation (EU) No 346/2013 – Article 14Pension ProductsPre-contractual disclosure requiredUCITS Management FirmsDirective 2009/65/EC – Article 69Investment Firms or AdvisersDirective 2014/65/EU – Article 24Credit Institutions or AdvisersDirective 2014/65/EU – Article 24Insurance IntermediariesDirective (EU) 2016/97 – Article 29AIFMs or ELTIFsRegulation (EU) 2015/760 – Article 23PEPP ProvidersRegulation (EU) 2019/1238 – Article 26

Article 8

Article 8 of the SFDR legislation requires that financial market participants that promote environmental or social characteristics in their financial products disclose clear information on how those characteristics are met, with indexes and references where relevant. Disclosures are also required to provide clear methodology used to track environmental or social characteristics.

Article 9

Article 9 of the SFDR legislation is similar to Article 8, but regarding investments. It requires financial market participants that promote environmental or social characteristics in their investment practices to pre-contractually disclose the objectives, nature, and methodology for tracking those characteristics. Article 9 also requires explanations for how their indexes that promote environmental or social characteristics differ from a broad market index.

All SFDR Document Articles Summarized

ArticleSummary1Subject matter description and purpose for the SFDR legislation2Definitions for technical, financial, and legal terminology in the SFDR legislation3SFDR Transparency requirements for published marketing materials and websites4Details regarding entity-level disclosure requirements for financial market participants5Transparency requirements for remuneration policies in compliance with SFDR6Disclosure requirements for sustainability risks factored into financial decisions7Disclosure requirements for the adverse sustainability impacts from the financial product or service8Transparency of the promotion of sustainable practices by the financial market participant according to SFDR9SFDR disclosure requirements for investments with sustainable objectives (carbon reduction, social impact, corruption impedance, etc.)10Requirements for publishing SFDR reports publicly online, especially any information relevant to Articles 8, 9, and 1111Requirements for publishing periodic updates to SFDR information12Requirement that published SFDR information is kept up to date 13Requirement that marketing communications never contradict information in SFDR reports14Compliance is to be monitored by “competent authorities” with necessary investigatory power to verify compliance with SFDR regulations15SFDR transparency requirements for IORPs and insurance intermediaries, refers to Articles 3-7 and 1016Member states may apply SFDR reporting requirements to “pension products”17Exemptions from SFDR reporting requirements, namely IBIPs, individuals, and insurance intermediaries — at the member states’ discretion.18ESAs are required to process (“take stock”) SFDR reports by September 10 every year. Reports shall be made public and transmitted to the EU Parliament and Council19(Only relevant in 2022)20Entry into force – 10 March 2021 – all articles apply as of 1 January 2022

What Businesses Need To Comply With SFDR

SFDR compliance can be tedious, especially when it requires financial market participants to gather information from other organizations they do business with to accurately compile the necessary information. Keeping ESG information accurate, up to date, and openly viewable on your organization website is required by the SFDR legislation. Even if organizations decide to hire outside help to meet SFDR compliance, they will often find that compiling and publishing the information requires a lot of in-house attention.

Below is a list of the general process for compiling and publishing SFDR reports on your own. However, many organizations find it more cost effective and efficient to use a simple software like Pulsora to guide them through the SFDR compliance process — you can read about how Pulsora works below.

1. Understand the requirements

Before gathering ESG information for your organization, it’s important to understand what the SFDR legislation requires from your organization type. This article is a good place to start. Refer to the table of organization types and corresponding EU reporting legislation in the previous section and read the directive that details the reporting requirements for your organization. Note that all SFDR reporting is required to be public and pre-contractual.

2. Outline information needs

Once you know what information you are required to report, it’s useful to create a document outlining what information needs to be collected and how it will be organized. Useful templates with outlines can be found online, but most are behind paywalls or catered to the specific organizations that created them. It’s also possible to use a spreadsheet or presentation software to construct your outline, but this can be time consuming and it is easy to miss essential information.

3. Collect data

After establishing a framework for collecting and reporting your data, it’s time to turn to your organization for the information. Remember that reporting the methodology used to collect and analyze ESG information is a required part of SFDR compliance. Collecting information from across large organizations is challenging. There is a significant risk of inadvertently missing information or collecting duplicate information that will produce flawed analyses. SFDR reporting software like Pulsora has built-in checks to make sure that all information is collected, duplicate information is identified, and analysis with methodology information is automated.

4. Finalizing SFDR reports

SFDR reports are not just the raw data collected from the organization — they require careful organization, analysis and presentation. If a robust report outline was used during data collection, it will likely have the necessary steps to construct the report from the collected ESG information in the outline. It is part of the SFDR reporting requirements that information and methodology be clear and understandable. Organizations that fail to meet a reasonable standard of clarity in their reports could face fines in their EU jurisdictions, even if they believe all necessary information is present. Below is a snapshot of an example SFDR report created with Pulsora where information is clear and readable.

5. Filing and disclosure

There are only three universal requirements for filing and disclosing SFDR reports according to the EU directive. First, all SFDR information must be made public on the reporting organizations’ websites. Second, all SFDR information must be presented on a pre-contractual basis to customers, partners, stakeholders, investors, etc. that do business with the organization. Third, the European Parliament and Council require access to SFDR information in a manner that can be easily aggregated and analyzed. Depending on the EU jurisdiction where your organization is based, your direct reporting requirements can vary. Some jurisdictions require direct submission of SFDR reports, some merely require notice of published reports, while others require no direct notification but may still take punitive action if SFDR reports are not easily located on the organization website.

Simplifying SFDR Compliance with Pulsora

Pulsora is an easy to use, browser-based software platform purpose built for ESG compliance. The sustainability management platform walks you step-by-step through the information gathering, organization, analysis, and presentation of all major ESG compliance regulations in the global economy, including SFDR. Organizations with complex operations choose Pulsora to simplify and streamline their ESG management and compliance.

For SFDR compliance, Pulsora connects stakeholders from across organizations to make data collection transparent, smooth, and simple. It reduces the time spent gathering data by keeping a clear record of what data exists, what data is needed, and who is responsible for gathering it. Once collected, Pulsora locks in the data for analysis, generating valuable reports that not only meet compliance requirements, but also generate insights for organizations to improve their decision making and ESG impact on their long term financial health.

To learn more about how Pulsora can help you streamline your SFDR disclosures, schedule a meeting with one of our ESG reporting and compliance experts.