In the ever-evolving sustainable finance landscape, European fund groups are grappling with a confusing question: which sustainability disclosure path under the Sustainable Finance Disclosure Regulation (SFDR) should they take? Article 6, 8 or 9?
Do they actually have a choice, as these are not fund classifications and the criteria have undergone more twists and turns than a suspense thriller, thanks to multiple ‘clarifications’ from regulators and the European Commission.
See also: – Articles 8 and 9 of the SFDR may ‘disappear completely’ as the consultation gets underway
The Dutch financial watchdog, the AFM, recently fired a shot across the bow. They warned fund managers against using terms such as ‘Article 8’ or ‘Article 9’ in their marketing to create the illusion of “a degree of sustainability” through a non-existent label.
On this side of the English Channel, we are all eyes and ears, waiting for the Financial Conduct Authority (FCA) to announce its final rules on investment labels and sustainability requirements (SDR). These rules will unravel the criteria needed to qualify for one of (probably) three coveted sustainability labels: actual fund classifications.
However, in September the European Commission pulled back the curtain on a thought-provoking consultation paper that looked at “exploring possible options to [SFDR] framework.” This was like adding a new plot twist to an already complicated story.
The introduction of an EU fund label scheme
The article begins with a barrage of questions about how SFDR interacts with the broader EU sustainable finance framework. It also acknowledges some “shortcomings” in the regulation. One of these is its unintentional transformation into a classification and labeling scheme, when it was never intended to be so.
As a result, and despite the proliferation of national ESG labels across Europe, the Commission is considering the idea of “developing a more precise product categorization system at EU level, based on precise criteria.”
The Commission’s consultation could result in one of two possible fund labeling schemes. The first is intended to extend Articles 8 and 9 by turning them into real labels. The second, more radical approach suggests erasing the distinction between Article 8 (promoting environmental and social characteristics) and Article 9 (sustainability as an objective). Instead, an entirely new set of labels would emerge that would dictate the criteria for disclosure.
Interestingly, these potential EU labels bear a striking similarity to the labels the FCA considered in its CP22/20 last year. You could summarize them as Impact, Sustainable, Transitioning (or, in FCA parlance, Sustainable Impact, Focus and Improvementer). There is even talk of a possible fourth category in the EU for funds with an exclusion policy.
But the real twist in the story lies in the introduction of “products with a transition focus” – a significant departure from the current definitions of the SFDR. The Commission’s consultation also considers the pros and cons of distinguishing between Sustainable and Impact, which is essentially similar to the difference between Articles 8 and 9. It examines the value of distinguishing between products with a social and ecological focus.
Should sustainability categories be mutually exclusive?
There’s another plot twist when we explore the concept of “mutually exclusive” categories. In the EU consultation, a fund can belong to only one category, even if it meets the criteria of several categories. On the other hand, the British interpretation insists that the definitions of the three categories are mutually exclusive, leaving no room for ambiguity.
Initially, when referring to the SFDR, the abbreviation ‘light green’ was used for Article 8 and ‘dark green’ for Article 9, implying a clear hierarchy. This led to further confusion when many Article 9 funds were “downgraded” to Article 8 last year, following a failed attempt by the Commission to clarify the sustainable investment threshold for Article 9 funds.
The consultation now asks whether additional disclosures should be required where a product falls within a specific category of sustainability products, further highlighting the hierarchy – a hierarchy that would persist if Articles 8 and 9 became the formal fund categories .
Interestingly, the FCA appears to be taking a different path. It refuses to insinuate that one category is greener than another, and even avoids using shades of green for the labels themselves. Their position is unequivocal: “There is no hierarchy between the proposed categories.”
Are UK and EU regulators aligning their sustainability disclosure regimes, or are they merely trapped by semantic differences, such as the number of categories and their mutual exclusivity?
Much of this will be resolved by the end of the year, when the FCA issues its policy statement and final rules. However, the EU consultation, which remains open until December 15, 2023, promises more twists and turns in the new year as the Commission processes responses.