Several market participants expected a complete overhaul of the Sustainable Finance Disclosures Regulation (SFDR) after the European Commission launched the targeted consultation on the implementation of the regulation on September 14, 2023.
These expectations are based on statements from the European Securities and Markets Authority (ESMA) and other national authorities that a transformation of SFDR from a disclosure regulation to a labeling system would help prevent greenwashing in the fund industry.
Much criticism focuses on Article 8 of the SFDR, because there are a large number of funds available in the EU to investors that meet the criteria of Article 8 funds, but in fact do not have a sustainable investment strategy. The mix of sustainability-related and conventional Article 8 funds is confusing for investors. Some market observers even stated that the current version of Article 8 is outdated.
Labeling of the fund
In light of these concerns, it is not surprising that the Dutch financial regulator AFM suggests that Articles 6, 8 and 9 must be thrown away and replaced with three different product labels (transition, sustainable and sustainable impact) to enable investors to understand the different types of sustainable investment products and their impact.
From my point of view, the European Commission should not go down that path because SFDR was released as a disclosure regulation, which has been misinterpreted by market participants as a labeling regime.
Nevertheless, it has become clear that the SFDR ecosystem needs an overhaul to bring regulations in line with newly launched initiatives such as the Global Sustainability Disclosure Standards (IFRS S1 and IFRS S2) adopted by the International Sustainability Standards Board in June issued.
It would also be logical for the Commission to do so determine a common language for all sustainability-related publications and statements as recorded, for example, in the Definitions for responsible investment approaches, published by the PRI in collaboration with the CFA Institute and the Global Sustainable Investment Alliance.
Such a common language would, in combination with clear rules for the use of ESG or sustainability-related terms in fund names as set out in the current consultation on the respective guidelines by ESMAhelp prevent greenwashing and make it easier for investors to understand the fund strategy and the potential impact of an investment in the relevant fund.
That said, it is clear that an additional labeling system would make it easier for retail investors to identify the funds that best suit their needs. Thus, clarifying SFDR and developing a labeling system would be the best course of action.
Another issue that the European Commission must address as part of a review of the SFDR is that disclosure requirements should put all funds on a level playing field. This means that all funds, regardless of the use of sustainable investment criteria, must have the same disclosure requirements regarding sustainability indicators. This would allow investors to make informed decisions about the negative or positive impact of their investments.
Because SFDR was the first sustainability-related regulation worldwide, the European Commission did not have a benchmark for what such a disclosure regulation should look like and what key figures are used by other regulators to identify sustainable practices. Therefore, it may also make sense to align at least some disclosure requirements with those of other regulators to facilitate overall compliance efforts for fund developers and companies.
More generally, it is even more important that the European Commission closes the gaps around a definitive definition of sustainability, as well as definitions and taxonomy for sustainability and governance, to make the revised SFDR a success.