On the 1st of January 2023, the Regulatory Technical Standards (RTS) come into force with Level 2 requirements, known as "SFDR Phase II" or "SFDR Level 2". It's important that real estate managers understand what this means for them and what the deliverables are.

Together with the EU Taxonomy and CSRD, the Sustainable Finance Disclosure Regulation (SFDR) forms part of the EU Sustainable Finance package. SFDR specifically is aimed at increasing transparency on sustainability among financial market participants (FMPs) toward end investors and at preventing greenwashing in the market for sustainable investment products.

The real estate sector is responsible for over a third of the EU’s CO2 emissions and 40% of its energy consumption. As such, there has been a proliferation of ESG strategies to minimize the drivers of climate change and other social and governance issues and marketing to this effect, so the importance of SFDR is clear.

In this article you will learn:

• who must comply with SFDR;
• what the specific deliverables are under the RTS; and
• how Scaler can help you get ready for the regulation and benefit from the insights.

Who must comply?

SFDR applies to financial market participants (FMPs) and financial advisors (FAs) in the EU (banks, insurers, asset managers and investment firms), including financial market participants with EU shareholders as well as those that promote themselves in the EU.

What is required under RTS?

SFDR imposes comprehensive sustainability disclosure requirements covering a broad range of environmental, social & governance (ESG) metrics at both entity- and product-level. Financial products must be designated as Article 6, 8 or 9 funds and make certain disclosures in keeping with this choice.

Article 6 - Article 6 covers funds which do not integrate any kind of sustainability into the investment process and when financial market participants deem sustainability risks not to be relevant.

Article 8, also known as ‘environmental and socially promoting’, applies “… where a financial product promotes, among other characteristics, environmental or social characteristics, or a combination of those characteristics, provided that the companies in which the investments are made follow good governance practices.”

Article 9, also known as ‘products targeting sustainable investments’, covers products targeting bespoke sustainable investments and applies “… where a financial product has sustainable investment as its objective and an index has been designated as a reference benchmark.”

Because of the stricter interpretation of ESG under Article 9, that is, sustainable investment as the objective, and given the uncertainty surrounding the regulation’s compliance requirements, many real estate managers are taking a more conservative approach and (re)classifying funds as Article 8. Therefore, this article will only cover Article 8 funds in detail.

Deliverables

The deliverables for Phase II can be broken down into 4 main areas:

1. Principle Adverse Impact statements (PAI)
2. Mandatory pre-contractual disclosure templates
3. Website disclosures
4. Mandatory periodic disclosure templates

1. Principle Adverse Impact Statements

Entity level

At the entity level, FMPs must disclose principal adverse impacts of investment decisions on sustainability factors – including detailed indicators for environmental and social impacts accompanied with textual explanations and commentaries using a mandatory reporting template. The PAIs are not applicable to FMPs with fewer than 500 employees. However, if they do not comply, they are required to explain why. Table 1 of Annex I lays out the template for the PAIs.

FMPs must include a summary, descriptions of policies to assess and actions to address principal adverse sustainability impacts, engagement policies, references to international standards, and a historical comparison from the second reference period onwards. These requirements must be complied with from 1 January 2023. The first information relating to the reference period should be published by 30 June 2023, corresponding to calendar year 2022, and by 30 June of each subsequent year.

The mandatory and voluntary indicators cover climate and environment, like GHG emissions (including disclosure of Scope 1, 2, and 3), biodiversity, water, and waste and social and governance indicators. Two of the mandatory indicators and five of the voluntary indicators are specific to real estate.

Mandatory

17. Exposure to fossil fuels through real estate assets, measured as the share of investments in real estate assets involved in the extraction, storage, transport, or manufacture of fossil fuels;

18. the exposure to energy-inefficient real estate assets, measured as the share of investments in energy inefficient real estate assets

Voluntary

18. GHG emissions

19. Energy consumption intensity

20. Waste production in operations

21. Raw materials consumption for new construction and major renovations

22. Land artificialization

Product level

At the financial product level, the RTS do not set out any specific requirements for the PAI, but by 30 December 2022, pre-contractual documents must contain the following disclosures:

• A clear explanation of whether and, if so, how a financial product considers PAI on sustainability factors; and
• A statement that information on PAI on sustainability factors is available in the annual reports.

2. Pre-contractual disclosures for Article 8

Annex II is a detailed, mandatory template in a Q&A format that needs to be populated and attached to pre-contractual disclosure documentation as an annex by 1 January 2023. At the beginning of the Annex, FMPs must indicate whether the product intends to make sustainable investments and whether it promotes environmental or social characteristics. In the main body of the pre-contractual disclosures, FMPs must provide information about the environmental or social characteristics available in the annex. Among the questions for sustainable investments that promote environmental characteristics, is to what extent they are aligned with the EU taxonomy, including a graphical representation in the form of a pie chart.

3. Website disclosures

Website disclosures apply from 1 January 2023. The RTS prescribe where and how disclosure on public websites should be presented, including mandatory sections for Article 8 and Article 9 (Articles 24 and 37 of the RTS), and what information should be included under each heading(Articles 24-49), and that information must be kept up to date. Among other information to be disclosed, FMPs must publish the data sources used to attain each of the environmental or social characteristics promoted by the Article 8 Financial Product or the sustainable investment objective of the Article 9 Financial Product; the measures taken to ensure data quality; how data are processed; the proportion of data that are estimated.

4. Periodic Disclosures for Article 8

Annex IV is the mandatory periodic disclosure template, required to be completed for any financial report produced after 1 January 2023, and which must be annexed to periodic reports. This template should be looked at side-by-side with the pre-contractual disclosure template, as ex ante and ex post disclosures of the same detailed information, to bring accountability to the disclosures made in pre-contractual documents. The template requires disclosure regarding the extent to which environmental and/or social characteristics that were promoted were actually met, including PAI on sustainability factors, asset allocation, proportion of investments in different sectors, information on activities for products that promote environmental and/or social characteristics, and performance compared to the designated reference benchmark.

Challenges for the real estate industry and how Scaler can help

Qualitative and quantitative metric requirements for the PAIs expose industry-specific challenges around ESG data and the need for robust data management systems and reporting mechanisms and is probably the most laborious part of SFDR.

Managers must strategically choose their product categorization with respect to sustainability and will need to identify the data streams they will use and determine the appropriate scoping, analysis and reporting. Data will need to be gathered on a yearly basis for mandatory reporting but effective monitoring of this data on an ongoing basis will be necessary in order to create greater value from the data.

The Scaler platform was built for the real estate industry, to meet the growing demand for data collection, monitoring, analysis and reporting, and designed specifically to incorporate new requirements as the landscape evolves. With Scaler you can measure the performance of your investments against all relevant PAI indicators for the real estate sector and calculate EU Taxonomy alignment. Scaler automatically computes mandatory and voluntary PAIs at the financial product and entity level, delivering information via a dynamic dashboard, making it easy to review data pertaining to SFDR compliance and gain actionable insight. When you've reviewed your data for accuracy, you can generate your PAIs at the click of a button for website and pre-contractual disclosures.

Get in touch for a demo to learn how we can help.