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SFDR: The Comply or Explain Mechanism
6/16/2022 ~ 10:33:31 AM

Question related to Regulation (EU) 2019/2088 of the European Parliament (Sustainable Finance Disclosure Regulation 2019/2088)

Published by the European Commission 14/07/2021:

The “comply or explain mechanism”

The underlying objective of Article 4 of Regulation 2019/2088 is to encourage financial market participants to pursue more sustainable investment strategies in terms of reducing negative externalities on sustainability caused by their investments. The compliance with disclosure requirements under Article 4 should incentivise the interest in investing in activities that do not harm environment or social justice, curb greenhouse gas emissions of their investments, stimulate investee companies to transition away from unsustainable activities and improve their environmental impacts or and even induce portfolio adjustments and divest from investments in activities that are harmful to sustainability. Article 4 also encourages financial advisers to pay more attention to how the consideration of negative externalities is integrated in their investment or insurance advice.

This is why the “comply or explain mechanism” under Article 4(1) of Regulation 2019/2088 distinguishes between ‘principal adverse impacts’ and ‘adverse impacts’.

Whilst the “comply mechanism” under point (a) of paragraph 1 encompasses the consideration of principal adverse impacts of investment decisions, financial market participants that decide not to apply the “comply mechanism”, must under point (b) of that paragraph that establishes “explain mechanism”, provide clear reasons for why they do not consider ‘adverse impacts’ of investment decisions on sustainability factors. Under point (b), by way of example, financial market participants must provide clear reasons for why they do not consider degradation of the environment or social injustice caused by their investments.

The aim of Article 4(3) and (4) of Regulation 2019/2088 is to introduce a more stringent “disclosure mechanism” and reduce a hypothetical incidence of application of “explain mechanism”.

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