The much-maligned Article 8 and Article 9 classifications, which identify the most sustainable funds under the EU’s disclosure regime, look likely to be overhauled next year.
The European and UK financial watchdogs are digesting findings from a 2023 review of the Sustainable Finance Disclosures Regulation (SFDR) which Ocorian, a funds’ services provider, expects will mean “more stringent ESG reporting” from 2025.
Ocorian says it has “analysed clues” from the formal review and predicts the Article 8 and 9 classifications might be revised or supplemented with new categories “to offer more clarity and comparability between different products”.
Ocorian notes that the EU and UK regulators are consulting with each other, suggesting a harmonised approach to labelling across both regions, “to help address investors’ challenges when trying to understand a financial product’s focus on sustainability”.
The European Commission was forced to review SFDR when it became apparent that the regime was failing to achieve its intended purpose to eradicate greenwashing.
For example, the Articles 8 and 9 disclosure requirements are often wrongly interpreted as providing a guarantee or regulated quality standard for sustainability.
Hatim Baheranwala, Cofounder and CEO of Treety, Ocorian’s ESG reporting partner, says: “The chosen approach was to define a set of expected disclosures and reports, and not undertake any formal labelling. This has unfortunately backfired during implementation, since the reporting categories such as Article 6, 8 & 9 have emerged as de facto labels. Additionally, the decision of allowing investment firms to establish their own definition for terms such as “sustainable investments” has led to even more confusion in the market, where differing firms have developed very diverse definitions for these terms.”
However, Dan Grandage, Head of Sustainable Investing at abrdn Investments, says removing articles 8 and 9 could make redundant the enormous amount of time, effort and energy that has gone into implementing the rules.
“What is more likely is an approach that leverages the useful work that has already been done and repurposes this into a framework that is suitable for use as a label. Potentially, that labelling framework could look similar to that proposed by the Financial Conduct Authority under its Sustainability Disclosure Requirements (SDR) and Sustainable Investment labels rules by the end of this year,” Grandage says.
Ocorian predicts additional changes to the SFDR including demanding fund managers provide more granular information on sustainability factors considered in investment decisions, portfolio characteristics related to sustainability objectives, and the impact of investments.
They also believe the concept of sustainability risks is likely to receive more focus. Disclosures might need to elaborate on how these risks are integrated into investment processes and risk management frameworks.
Baheranwala calls on fund managers to pre-empt a regulatory overhaul and update existing processes.
“While the regime is being improved and simplified, by entering into this review the EU has clearly signalled that its aim is to eliminate loopholes and ensure standardised sustainability reporting across the entire market.
“We recommend that all alternative asset managers start by reviewing their current ESG and sustainability reporting processes and ensure that they are taking steps to ensure completeness, credibility and efficiency in their reporting flows – just like they do for their financial disclosures.”
