Sustainability Data Must Be Used for Purpose for SFDR Reporting, Especially for Mandatory PAIs
The market demand for sustainable investing is large. The value of sustainable investment in major financial markets globally stood at $35.3 trillion, according to the Global Sustainable Investment Alliance (GSIA), and accounts for 36% of all professionally managed assets across the U.S., Canada, Japan, Australasia and Europe. And that market is growing. The last two years alone have seen growth of 15 percent. Additionally, recent research from FTSE Russell, an LSEG company like Refinitiv is, shows that Asset Owners are specifically keen on increasing their allocations to sustainable investing: “Our research confirms that sustainable investment has become part of mainstream investing: 86% of asset owners globally are implementing sustainable investment in their investment strategies (up from 76% in 2021).
As part of this growing trend, 44% of respondents are incorporating sustainable investment and climate considerations into their Strategic Asset Allocation (SAA) models or framework, up from 33% in 2021.” Asset Owners often act as leading indicators in the institutional investing market, as Asset Managers serve the Asset Owner community.
To meet that demand, some asset managers may be cutting corners in creating sustainable funds. In an assessment of 15,000 funds and their Sustainable Finance Disclosure Regulation (SFDR) classification, Clarity AI focused on the 750 Article 9 funds within this universe that have sufficient information on at least 80% of their holdings. Clarity AI’s research shows that many Article 9 funds might be noncompliant with the regulation’s do no significant harm criteria.
In SFDR, there are three main criteria to define a sustainable investment:
- It must contribute to an environmental or social objective
- It must not significantly harm other environmental or social objectives (DNSH)
- The investee company must follow good governance processes (GG)
To classify an organization as a sustainable investment, it must fulfill all three of the above criteria and recent guidance on Article 9 funds suggests that the funds should comprise nearly 100% sustainable investments.
While a small share of investments in companies that are not sustainable is expected, Clarity AI found that nearly 20% of the Article 9 funds analyzed have more than 10% exposure to companies that have violations of the UNGC principles or the OECD Guidelines for multinational enterprises. 40% have more than 5% exposure.
Additionally, issuers of Article 9 funds have recently been voluntarily downgrading them to Article 8. “More than a tenth of all Article 9 funds – just under 130 – have announced plans to ditch the classification since the start of November 2022. These include many ETFs tracking Paris-aligned (PAB) and Climate Transition benchmarks (CTB),” according to Responsible Investor. Amundi has made many of these changes, and they account for more than 100 funds in the category, with a total of about 45-billion Euros in assets under management within those funds. Other major asset managers downgrading funds include, but are not limited to, HSBC and UBS.
With the moves in the market to reassess what really is a sustainable investment, the most informed answers come from reliable data – without which, those who are required to report for SFDR may report incorrectly. Consider that many sustainability data providers pull data from publicly available sources without tailoring it to EU regulatory requirements, which can have the following pitfalls:
- Reports for sustainability data are often formatted for marketing purposes, not for standardized data collection
- Humans pulling data from tens of thousands of sources can lead to data quality issues
- Companies don’t necessarily report in exact accordance with the investor SFDR requirements
Using advanced technology to solve for this helps to align to the regulators requirement for “best effort” reporting. This can be illustrated with the example of a specific data error, in this case related to SFDR PAI 8 – Emissions to water:
- For Covestro, some providers are using the value 728kt emissions to water.
- The value should be 0.29kt (2,500 times smaller), which corresponds only to phosphate, nitrates and heavy metals values as the regulation specifies.
- 728kt includes inorganic salts, which should not be included as per the regulation.
The team at Clarity AI has also found issues with data specific to five other mandatory SFDR PAIs – numbers 4, 7, 9, 10 and 11:
- PAI 4 – Exposure to companies in the fossil fuel sector: Data issues stemming from leveraging existing metrics for fossil fuel exposures data without considering the specifications of the SFDR regulation (e.g., distribution, trading).
- PAI 7 – Negative effect on areas of biodiversity: Data issues stemming from only considering companies’ biodiversity protection policies and not incorporating controversies or proximity to protected areas.
- PAI 9 – Hazardous waste ratio: Data issues stemming from not considering radioactive waste, as required by regulation.
- PAI 10 – Violations of UNGC & OECD guidelines: Data issues stemming from using controversies that are not proven violations, not using controversies at all or using only UNGC guidelines (i.e., not using both UNGC and OECD guidelines).
- PAI 11 – Lack processes to comply with UNGC & OECD guidelines: Data issues stemming from only considering if companies are signatories and not evaluating if companies have processes in place.
As the requirements for SFDR are highly specific, financial market participants who are required to report should consider the advantages that reporting providers using advanced technology fit for the regulation have. To learn more about SFDR Reporting Professional powered by Clarity AI, reach out to your Refinitiv account manager.
