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SFDR will change investors’ approach to sustainability

SFDR’s objectives are noteworthy and for the common good, says Morgan Stanley Investment Management’s head of sustainability for global real assets, Mona Benisi.

Dismissing the European Union’s Sustainable Finance Disclosure Regulation as an EU-centric framework that does not apply to your non-European fund would be a mistake. In my opinion, SFDR is likely to fundamentally change how real estate investors globally incorporate sustainability into every stage of the investment cycle.

SFDR is a disclosure regulation and, put simply, has two underlying policy objectives: first, preventing greenwashing, and second, directing capital into sustainable economic activities.

These policy objectives are achieved by introducing specific obligations for asset managers at the entity level, and investment products at the fund level, including:

  • Detailed disclosure obligations to be made in all stages of the investment lifecycle: prior to investments (eg, in marketing materials) and throughout ownership and (eg, annual periodic disclosures); and
  • The requirement to classify funds’ approaches to sustainability in one of three categories: Article 8, those that are promoting environmental and social characteristics; Article 9, those that have a sustainable investment objective; and other, meaning neither Article 8 nor 9.

SFDR went into force in March 2021 and is applicable to multiple types of asset owners, such as certain insurance and pension product providers, EU alternative investment fund managers as well as non-EU managers/financial advisers marketing products to EU investors.

“The regulation has a one-size-fits-all approach that it seeks to make ‘fit’ across multiple asset classes”
Mona Benisi

SFDR’s indirect impact is expected to have a global reach with many of its requirements likely to determine how the real estate industry sets, monitors and reports on its sustainability goals. So, it is crucial to do your homework on SFDR.

Among the many challenges that non-European fund managers will face in implementing SFDR is that it has been designed by Europeans for Europeans. There appears to have been little thought, at least to date, put into how SFDR will align with similar non-EU sustainability disclosure requirements or plans – such as the SEC’s anticipated climate rulemaking. It is unclear how different jurisdictions will supervise and administer this new regulation.

SFDR also appears to apply the same level of requirements for both debt and equity investments. Without the informational benefits that often come with equity ownership, we suspect that it will be difficult for debt investors to both access and ensure the accuracy of SFDR-relevant data.

Another area to note with SFDR is that it seems rather public market-centric. The regulation has a one-size-fits-all approach that it seeks to make ‘fit’ across multiple asset classes. We foresee challenges particularly for private markets given the dearth of data and limited transparency.

Despite these challenges, and the resources required to understand and execute on this regulation, most stakeholders in the private markets are supportive of what SFDR (together with the EU’s Sustainable Finance taxonomy) will likely achieve – Increase transparency around ESG and reduce greenwashing; increase capital flow toward sustainable strategies; and enhance clients’ ability to make informed investing decisions.