Expert blog – August 3, 2021
Dylan Perales, Sustainability Lead at StartGreen, describes in this blog what the regulation of sustainability information means for StartGreen and its investors.
What is the purpose of the SFDR?
Since March 10, 2021, the Sustainable Finance Disclosure Regulation has been in effect. The regulation is better known by its international name: the Sustainable Finance Disclosure Regulation, or SFDR for short. This regulation dictates to financial market participants what they must communicate regarding certain sustainability matters. In this way, the EU aims to harmonize information disclosure and increase transparency. The ultimate goal: making it easier for end investors to compare financial products based on environmental, social, and governance (ESG) risks as well as sustainable objectives.
European Action Plan
The SFDR is part of the European Commission’s Action Plan for Financing Sustainable Growth. The EU Taxonomy is also part of this: a new classification system designed to provide clarity on what is considered sustainable. With this action plan, the EU aims to give the sustainable transition a push in the right direction and prevent greenwashing. My first reaction was: ‘How cool, it’s really getting serious now!’ Because even parties that consider sustainability a side issue or a hygiene factor are now obliged to pay serious attention to it.
My first reaction was: ‘How cool, it’s really getting serious now!’
Challenging implementation
It soon became clear to us that implementing the regulation presented a significant challenge for StartGreen and other asset managers. The SFDR affects all sorts of processes: due diligence, drafting contracts, and reporting. Implementation and execution therefore require collaboration between various disciplines, such as Legal, Control, Risk & Compliance, and the investment team. Furthermore, the guidelines in the SFDR are not equally clear everywhere. For instance, what constitutes ‘sufficient communication’? That is why we started looking at what we had already included in our sustainability policy and what was still missing. Subsequently, we began to close that gap.
Benefits of SFDR
The biggest advantage is that investors can more easily determine whether an investment is truly green. Both the SFDR and the EU Taxonomy make this easier through greater transparency and harmonization. Although this framework is not yet complete, it is certainly a step in the right direction. And because this regulation comes from the government, it carries more weight than the many existing frameworks for sustainable reporting. For organizations that do not yet have a policy in this area, the SFDR provides a useful framework. It also enables us to see if we are aligned in terms of policy and where we can add elements.
Need to have
The StartGreen team has taken the SFDR implementation very seriously. Out of intrinsic motivation, we were already recording quite a lot; now it is an obligation. Our shareholders are also demanding more and more information. It has moved from nice to have to need to have. The downside is that the SFDR pushes parties through a certain sieve; that is not always optimal. To give an example: StartGreen is currently not yet active internationally, but the SFDR does oblige us to report on whether we comply with certain guidelines that are clearly less relevant for companies in the Netherlands, such as human rights in developing countries.
In addition, the reporting obligations are a challenge. Where we previously focused on about three positive impact KPIs per company, the SFDR now requires reporting at the fund level on more than ten negative impact indicators (better known as the principal adverse sustainability impacts).
What have we done specifically?
We have made our sustainability policy on the website clearer. We describe very explicitly there how we handle impact and how we measure it. We also now share our ESG policy externally and describe the sustainability risks that our portfolios themselves face. In addition to the effect of the company on its environment, we describe the effect of the environment (such as climate change) on the company.
Furthermore, we now report more in accordance with the SFDR guidelines. We already had some indicators in our reporting package, but based on the guidelines in the SFDR, we have started measuring more and more specifically. For example, regarding diversity, we already reported the male-female ratio in a company. Now—partly due to the SFDR—we also look specifically at this ratio within the company’s board.
Mapping sustainability risks
Because of the SFDR, we have also started mapping the effects of climate change on our portfolio more extensively. We were already doing this for Energiefonds Overijssel, but now we are looking at all our funds to see what effect the transition could have on the portfolios. For example, what happens if the groundwater level in the Netherlands drops? That can be a direct financial risk for real estate, as a low water level can cause wood rot in foundation piles. This, in turn, can have an indirect effect on the funds that have invested in making real estate more sustainable, for example with solar panels on the roof.
Social annual accounts
The SFDR obliges all asset managers to share their sustainability policy. It would be great if, in the future, every financial service provider were required to produce social annual accounts regarding (positive and negative) impact. Because I believe that when you start measuring things, you become more conscious of them and start acting accordingly. For example, I notice a positive effect in the area of diversity. This has received a lot of attention within the venture capital sector over the past year. By including this in reports, it remains top-of-mind for the investment team as well as for entrepreneurs, which I believe leads to the importance of diversity being weighed more heavily during new recruitment rounds.
Accelerating the transition
What I find most beautiful is that the SFDR, through increased harmonization and transparency, can help convince investors to invest more in sustainable financing products. This releases more (private) capital to realize the transition to a sustainable economy. This latter point aligns perfectly with StartGreen’s goal as well as my own. That is why I wholeheartedly welcome this regulation.
This spring, Dylan shared his experience regarding the implementation of the SFDR in a webinar by the NVP (Dutch Private Equity and Venture Capital Association). You can watch the video back on YouTube.
