By Oliver Dundo
Member of Mashora’s Network of Experts
On March 10, the European Union Sustainable Finance Disclosure Regulation (SFDR) came into effect. The SFDR requires that asset managers show “tangible and measurable plans” on ESG, with the aim of preventing greenwashing. This has implications for asset managers in the EU and beyond. The SFDR, directly and indirectly, affects the EU-Africa financial relationship.
The proposals for SFDR resulted from the European Commission’s realization that there was a lack of transparency on the degree of sustainability of financial products. There was equally a lack of transparency on how sustainability risks were considered in offering financial advisory. The effect of this was that investors did not obtain full information upon which to base their investment decisions.
Other SFDR rules will be phased-in in the months ahead. These include the Regulatory Technical Standards supplementing the SFDR. The objective of the SFDR is to encourage the channelling of private investment towards sustainable investing.
Consequently, the SFDR will support the United Nations Framework Convention on Climate Change, the United Nation’s Sustainable Development Goals (the SDGs) while preventing “greenwashing”.
In this article, we delve into the application of the SFDR. In particular, we highlight how the SFDR is likely to impact Africa. We outline reporting criteria and implementation measures that Africa should take to enforce the SFDR’s provisions.
Application of SFDR
The rules primarily apply to business and financial market participants in the EU. First is a direct application to the EU entities. Secondly is an indirect application for non-EU entities.
The indirect application comes in the form of EU subsidiaries, provisions of services in the EU and the market pressures likely to arise from the seemingly unstoppable global shift towards sustainable investing.
Impact of SFDR in Africa
World over, the economy is shifting, customers are scouting for more sustainable investing options. Africa is no exception. The last few years have seen an increased appetite towards sustainability-driven companies.
SFDR, like in the EU, could be a key milestone for Africa’s asset management space, in the journey towards reorienting capital flows towards sustainability.
Financial services providers and firms based in Africa, like other non-EU firms, will thus be affected. The first is direct, where African investment fund managers market or offer funds to EU investors under national/local private placement regimes. In such cases, the investment fund managers or firms will have to follow SFDR disclosure requirements.
Secondly, is indirectly through relationships with EU regulated firms or clients. EU based entities will require relevant information and documentation from financial market players in whose products they invest. This means Africa should prepare to have a conversation with EU institutional investors and other regulated clients on ESG disclosures.
Thirdly, the SFDR is likely to further fuel market pressures arising from clients and civil society groups that have been leading the charge for sustainable investment. According to a study conducted by PWC, approximately 77% of institutional investors are likely to stop purchasing non-ESG products in the next two years.
As a result, regulation, local and regional pressure, as well as public and political pressure, are likely to push Africa’s financial market participants to comply with the SFDR disclosure requirements.
Besides the regulatory efforts, Covid-19 has been a timely reminder and a key contributor to the shift towards sustainable investing. With competition for investor capital due to get stiffer, Africa’s managers will no longer ignore calls for more transparency and incorporation of ESG factors into their investment portfolios.
Implementation of SFDR in Africa will be a game-changer for the financial services industry. First, it is likely to protect African investors by enabling them to make informed investment decisions. This will impact existing or prospective investor appetite. It is also likely to result in a competitive advantage to Africa’s financial market players. For example, it could lead to better costs of capital compared to less sustainability-conscious companies.
Secondly, enhancing the sustainability profile of funds in Africa makes them better understood and more comparable by end-investors. This makes it easier for investors to put their money where their values and belief lie. Analyzing sustainability risks is an integral part of building asset portfolios that are capable of delivering sustainable financial returns. This can be easily achieved through ESG reporting in line with SFDR.
Reporting Requirements under the SFDR
Reporting requirements under SFDR are twofold. First is disclosure about sustainability information at the firm-level, which is mandatory. This entails legal entity level disclosure (corporate/firm level).
The second level is the product-level. It entails product pre-contractual disclosure, product website disclosures and product periodic reports. It obligates financial market players to disclose information on the extent of sustainability of products they offer.
Each level comes with both general and specific disclosure requirements. On both levels, financial market players are required to report their Principal Adverse Impacts (PAI). This comprises a list of sustainability factors such as respect for human rights, anti-bribery and anti-corruption matters, waste, biodiversity and GHG emissions..
To start a journey towards compliance with SFDR, Africa’s financial market players need to do the following:
- determine what disclosure requirements apply to their firms or products based on the two levels of compliance;
- map out the necessary actions towards compliance, including a review of their data, process maps and procedures;
- identify necessary steps to ensure compliance with SFDR. This includes developing policies in the key classes of ESG. It could also include amending or updating existing policies with ESG factors in mind;
- achieve disclosure obligations on both levels, firm and product, and;
- provide information on their internal policy documents, pre-contractual documents and periodic reports on their websites.
The application of SFDR will not only influence capital raising activities across Africa but also provide a competitive advantage to firms that will align their business with SFDR. Africa’s fund managers should be attentive as to how they position their funds ahead of more detailed rules to be rolled out in 2022.