It was only a matter of time before the European Commission was forced to rewrite the Sustainable Finance Disclosure Regulations (SFDR) having deemed them unfit for purpose.
A comprehensive review of the SFDR by the Commission found the current framework results in disclosures that are “too long and complex, making it difficult for investors to understand and compare the environmental or social characteristics of financial products”.
Further the EC conceded that the SFDR has effectively been used as a de facto labelling system, “causing confusion – particularly for retail investors – and increasing the risk of greenwashing and mis-selling”.
The new look SFDR promises a more coherent, effective and user-friendly EU sustainable finance framework, and includes:
· The introduction of clearer sustainable product categories underpinned by clear minimum criteria.
· Simplified disclosures that refocus information on the core elements of a product’s sustainability strategy and objectives.
· Prioritising product disclosures and leaving corporate-level disclosures, such as mandatory entity-level PAI reporting, out of the framework.
· Stronger alignment with horizontal frameworks, including clearer integration of fund naming rules and closer consistency with the CSRD/ESRS framework.
· Removal of portfolio management and investment advice from the scope, ensuring coherence with MiFID preferences and avoiding duplicative disclosures.
Michelle Ko, Investment Funds Lawyer at Linklaters, said theintroduction of specific qualifying criteria for each product category including mandatory exclusions will create a level playing field.
She added: “The specific qualifying criteria also means that the new “ESG basics” category is an uplift compared to today’s “Article 8” and certain products which are “Article 8” today would have to be uncategorised under the new regime. This is a significant development, given uncategorised products will be very limited in what they can say about ESG.”
Tanguy van de Werve, European Fund and Asset Management Association (EFAMA) Director General, welcomed the new regime calling it an advancement toward a sustainable finance framework that is effective in practice.
“Establishing clearer product categories and more focused disclosure requirements will enable investors to better understand, compare, and trust the sustainability strategies of financial products. With proper implementation guidance, this proposal can greatly improve informed decision-making and accelerate Europe’s transition to sustainability.”
However, despite welcoming the revised SFDR, EFAMA said “important challenges remain”.
EFAMA pointed to the “significantly decreased scope of CSRD reporting and the absence of binding requirements for third-party ESG data providers will limit access to consistent ESG information”.
Van de Werve said: “We therefore recommend a proportionate and transparent approach to the use of ESG data estimates when implementing the new SFDR rules. We also regret that the proposal introduces new minimum exclusion criteria that go beyond the traditional CTB/PAB approach of the ESMA fund-naming guidelines.”
EFAMA said clear guidance will be needed to ensure a smooth transition from today’s Articles 8 and 9 to the new product categories, and to align MiFID sustainability preferences with the revised SFDR framework to avoid confusion for end investors.
Anyve Arakelijan, Senior Policy Advisor at EFAMA, said: “The new rules will still require careful reassessment of how products are classified in practice. A major ongoing challenge will be accessing comparable and reliable ESG data. If a considerable number of companies are not reporting under CSRD, asset managers will be more reliant on estimates and third-party ESG data providers for the data they need to make investment decisions and do their own reporting under SFDR.”
There is also concern that the suggested basic criteria and limited exclusions risk leaving room for greenwashing.
Aleksandra Palinska, Executive Director of Eurosif, argued that while the new impact transparency layer is a welcome addition, the deletion of key entity-level disclosures and rollback in product-level disclosures could further reduce comparability for investors. Excluding portfolio managers from the scope may also create operational gaps.
“The European Commission proposal contains some positive steps forward. However, it falls short of establishing sufficiently robust criteria and meaningful disclosures needed to meet end investors’ expectations and support the EU’s sustainable growth objectives,” Palinska said.
