Last month the EU Commission published a report summarising the 324 submissions on the review of the Sustainable Finance Disclosure Regulation (SFDR), following the 2023 consultation. This has turned into one of the most controversial ESG regulations enacted in Brussels. The Disclosure Regulation could also be referred to as the „Article-8-Article-9 Regulation“. These EU rules have led to incomprehension and uproar among investors and in the fund industry.
The revision of the SFDR, which only came into effect in 2021, now seems more necessary than ever.
A major misunderstanding
The SFDR is also seen as widely misunderstood. The Disclosure Regulation does stipulate certain transparency requirements in relation to sustainability risk policy. However, it does not actually say what sustainable products are. An categorisation of the fund world into ´green’ and ´brown´ remains problematic on the basis of the Regulation. However, because the SFDR is the EU-wide set of rules, transparency has often been equated with ‘green“.
Centrepiece of the action plan
It has always been clear that the SFDR is a centrepiece of the EU Action Plan. It is intended to define standards and labels for green financial products. Specifically, it obliges fund providers to set out the objectives of their funds according to sustainability criteria – in the fund prospectus. Strict minimum standards apply to disclosure, which are intended to prevent greenwashing. This essentially applies to two groups: Article 8 funds and Article 9 funds.
Article 8 products advertise social or environmental characteristics, and can invest in sustainable investments without sustainability being the main objective. Article 9 products have a sustainable investment objective.
The extent to which the EU world of disclosure deviates from the usual categories of sustainable funds is shown by statistics from Scope Group. On the one hand, a Scope study lists the number of funds that have sustainability characteristics in accordance with the SFDR. Most recently, this was 6,200, or every second fund.
On the other hand, Scope has peer groups with a clearly recognisable ESG focus. There are only 726 funds in these peer groups, which is only a small proportion of the fund universe. To avoid misunderstandings, Scope intends to „make it clearer in the future that the SFDR classification differs from the Scope classification“.
The latest EU Commission consultation gives a highly critical picture of the SFDR. For example, there is no consensus on the usefulness of company-level disclosures on remuneration policy (39% in favour, 26% against) or on adverse sustainability impacts (31% in favour, 31% against). Most of those in the fund sector call for at least a simplification of the disclosure requirements, in conjunction with other EU regulations.
The vast majority of respondents believe that the introduction of new EU sustainability categories would be helpful to assess investors’ sustainability preferences (69%), to combat greenwashing (64%) and to better understand the sustainability strategies and objectives of products. Over 70% of respondents believe that disclosure alone is not enough to achieve these goals.
Opinions are divided as to whether product categories should be based on new criteria, or whether Articles 8 and 9 of the SFDR should be amended. Nevertheless, there is broad agreement among respondents on common principles for the categories. A new system should be orientated towards retail investors, have an international dimension, and incorporate the concept of transition finance. There is overwhelming support (72%) for the introduction of a special category for products geared towards the sustainable transition.
A fourth point in favour of a new regulation concerns neutrality criteria. Respondents said that the underlying criteria must be asset-neutral, and should apply to all types of financial products.
The feedback reflects the main focus of the German Investment Funds Association (BVI) position, which gives cause for optimism with regard to further discussions.
UK leads the way
Whilst the EU is not currently expecting a quick adoption, the UK has taken the lead. In the former EU country, the Financial Conduct Authority (FCA) recently published a comprehensive package of measures that sets out the framework for sustainability transparency and corresponding product classification. The FCA has introduced Sustainability Disclosure Requirements (SDR). This means that asset managers will soon be able to use one of four investment labels (Sustainability Focus, Sustainability Improvers, Sustainability Impact, Sustainability Mixed Goals) in conjunction with the corresponding disclosures.
The categories are designed to reflect the wishes of different consumer preferences. Sustainability Focus investments mainly involve environmental or social sustainability. This category applies to funds with a high level of sustainability (the consultation paper stated at least 70% sustainable assets).
The Sustainability Improvers category comprises investments that are not yet sustainable but are expected to have a positive impact on the environment or society in the future. The aim is therefore to achieve a measurable improvement in the underlying ESG performance.
Sustainability Impact includes investments that aim to achieve pre-defined ESG outcomes, making measurable contributions to environmentally or socially sustainable progress. The Sustainability Mixed Goals category is a new addition. This is for products with a sustainability objective to invest at least 70% in line with a combination of the sustainability objectives for the other labels.
EU roadmap
The EU is not yet as far along as the UK. It remains to be seen when the Commission will present a concept for revising the Disclosure Regulation. It has initially commissioned the EU Platform on Sustainable Finance with further work on the product categories. A report from the platform is due by the end of June.
„Although the EU legislators have adopted a flood of detailed regulations, they have not yet established any generally applicable definitions of what constitutes a sustainable product,“ writes the BVI, pointing out once again that the Disclosure Regulation plus Taxonomy have so far only introduced transparency obligations.
The BVI fund is also in favour of a sustainable transition product category. It believes that clear rules for assets that support the transition from brown to green business models would be an advantage: „This could curb discussions about greenwashing.“
