SFDR One Year on

European efforts to bring transparency to ESG funds haven’t addressed fears of greenwashing.

Almost a year since the European Commission introduced the Sustainable Finance Disclosure Regulation (SFDR), the European investment community remains divided over how to classify the ESG risks and impacts of their investments. Different approaches to product classification have sown confusion and raised greenwashing concerns among both institutional and retail investors.

Despite this, investment levels in SFDR’s Article 8 and Article 9 funds continue to grow, reaching €4.05 trillion at the end of December 2021 – representing 42.4% of all funds sold in the European Union, says Morningstar.

This explainer sets out the current state of play and how clarity might be achieved, both in Europe and beyond.

How does SFDR define Article 8 and Article 9 funds?

SFDR Level 1 requires asset management companies to provide information about their investments’ ESG risks and also their impact on society and the environment. It lays down sustainability disclosure obligations for manufacturers of financial products and financial advisers toward end-investors.

Within SFDR Level 1, which came into effect on 10 March 2021, asset managers are required to sort ESG funds and other investment products into three categories – Articles 6, 8 and 9. The main goal of the legislation is to give greater assurance to investors that they are investing in products matching their own sustainability priorities, without the risk of falling prey to greenwashing.

Article 6 covers funds that do not integrate any kind of sustainability into the investment process. Examples could include stocks such as tobacco companies or thermal coal producers. Asset managers are required to clearly label such funds as non-sustainable.

Article 8 funds, sometimes known as ‘light green’ are financial products that promote “environmental and/or social characteristics”, provided that companies in which the investments are made follow good governance practices. Article 9 (‘dark green’) refers to products that have a sustainable investment objective; all holdings within a fund must be sustainable investments that meet the standard of “do no significant harm”.

SFDR requires that asset managers disclose ESG information for all funds, with the level of detail in disclosure increasing up to Article 9.

What impact has SFDR had?

Morningstar estimates that Article 8 and 9 funds captured 64% of EU fund inflows during Q4 2021. The regulation has “spurred product development and innovation”, it says. In the quarter, nearly 200 new Article 8 and Article 9 funds were launched, accounting for 54% of new funds in the EU.

While broad ESG and sustainable strategies represented the bulk of the new products, funds with an environmental theme accounted for about one fifth of new launches.

Article 8 funds experienced steady growth right from their introduction. The European Fund and Asset Management Association (EFAMA) reported that net assets of Article 8 funds totalled €3.7 trillion, or 22%, of the European fund market at the end of Q1 2021. The main domiciles of Article 8 funds were Luxembourg (35%), France (16%), the Netherlands (13%), Sweden (13%) and Ireland (9%). In terms of the domestic market share of Article 8 funds, Sweden took the top spot (92%), followed by Belgium (50%) and the Netherlands (48%).

But Article 9 fund net assets amounted to just €340 billion, or about 2% of the European fund market, at the end of Q1 2021, said EFAMA’s Market Insights report. Luxembourg accounted for more than half of total Article 9 fund net assets, followed by France (16%) and the Netherlands (9%).

According to investment consultants bfinance, the growth in demand for Article 8 and 9 funds has led to a price war, with asset managers offering temporary discounts to accrue assets.

Why are Article 8 and 9 funds difficult to define?

While SFDR was designed to avoid greenwashing, it has not achieved its objective.

Morningstar says “a lack of clear policy guidance” has resulted in different approaches to product classification, which in turn have led to confusion.

“Asset managers have taken different interpretations of the definitions, some opting for a softer approach than others,” it adds. “This has resulted in an unexpectedly high number and broad range of products labelled Article 8 and Article 9 that aim to address a variety of sustainability preferences and investment objectives.”

This high number could be partly the result of pressure on asset managers from distributors and fund buyers who say they will consider only Article 8 or Article 9 funds, says Hortense Bioy, Global Director of Sustainability Research, Manager Research at Morningstar.

Asset managers’ approaches range from using ESG exclusions to focusing on impact. Many employ a best-in-class approach and/or focus on specific sustainability themes such as climate transition, ocean finance, or a focus on one or more of the UN Sustainable Development Goals (SDGs). Many also use stewardship to nudge companies towards better ESG practices. ESG approaches are often used in combination and are by no means mutually exclusive at the fund level.

Morningstar research suggests asset managers are “quite comfortable” with how they have defined their funds, demonstrating confidence in their compliance with SFDR, says Bioy. There is little evidence that managers are downgrading definitions and nothing to suggest they consider themselves as being generous with their interpretations.

During the past year, asset managers continued to reclassify strategies from Article 6 into Article 8 or Article 9 by enhancing ESG integration processes, adding ESG exclusions, or switching to new strategies. Changes to justify a reclassification vary in depth and breadth, says Morningstar.

Are Article 8 and 9 funds contributing positively to climate mitigation and other sustainable development objectives?

The jury is very much out for now. Several studies have noted that the lack of difference between ‘light’ and ‘dark’ green funds, some pointing out that financed emissions of Article 8 and 9 funds are very similar, and indeed not that different from Article 6 funds.

There are particular concerns around Article 8 funds, with many of the largest not even marketing themselves as green, suggesting they have been categorised opportunistically by their creators. That said, some Article 8 funds score almost as well on carbon risks as Article 9 funds.

Globally, however, there remains a worrying gap between branding and impact. In August, climate think tank InfluenceMap released a report indicating that the majority of climate-themed investment funds had a negative Portfolio Paris Alignment score. The organisation called for increased regulatory oversight of the marketing and transparency of funds. In the broad ESG category, InfluenceMap identified 593 equity funds with over US$265 billion in total net assets, of which 71% had a negative Portfolio Paris Alignment score.

Of the 130 climate-themed funds, with titles such as ‘low carbon’, ‘fossil fuel free’ and ‘green energy’, and over US$67 billion in total net assets, 55% had a negative Paris Agreement alignment score. The lowest score was -42%, with the best scoring fund hitting +90%.

What is being done to clarify definitions?

While the three-way split between Articles 6, 8 and 9 was designed to define the disclosures required of asset managers, they have evolved to become “de facto labelling systems”, says Andy Pettit, Director, Policy Research at Morningstar. It is, however, a system with high levels of imprecision and no minimum requirements to meet criteria.

Pettit says the market can expect more refinement of Articles 8 and 9 funds in future as disclosure requirements are improved and minimum criteria are developed.

Delays in the regulatory agenda and the interaction between SFDR and the EU Taxonomy have created complexity. The key to unlocking more precise data on the content of SFDR funds lies in the SFDR Level 2 Regulatory Technical Standards (RTSs), which have been delayed until the end of the year, says Pettit. Once these have been introduced, fixed form templates for Article 8 and Article 9 funds will be published. This should give more details about the characteristics and metrics to support how the objectives of funds are being pursued and how successfully.

In the absence of the RTSs, asset managers with Article 8 funds have more freedom in how they employ investment strategies to promote environmental or social activities. Strategies can therefore be incredibly varied.

Article 8 of the taxonomy requires companies falling under the Corporate Sustainability Reporting Directive (CSRD) to identify and disclose the eligibility of their activities in line with the taxonomy’s technical screening criteria. This will give asset managers more insight into the environmental sustainability performance of investee companies, thus informing their disclosures under SFDR Level 2.

In February 2022, the European Securities and Markets Authority (ESMA) said it would start working on a legal definition of greenwashing to underpin enforcement action, as part of the regulator’s sustainable finance roadmap. ESMA said there was a need to address greenwashing “without delay”.

As greenwashing is a “multifaceted issue requiring a number of measures”, more standardised terminology will allow for increased differentiation between ESG products that are “varying levels of green”, said Alessandro d’Eri, Senior Policy Officer at ESMA.

He added that ESMA was “very aware” that the market was in a transition phase and said regulators should approach greenwashing from a supervisory stance to “better foster clarity on how to best define products as green”.

How are other fund labelling regimes evolving?

The CFA Institute, through its Global ESG Disclosure Standards for Investment Products, is also looking to provide clarity around sustainable fund products. The voluntary framework outlines disclosure requirements designed to better distinguish between fund products and drive communication between the sustainability-focused buyers and an industry which is marketing increasing numbers of ESG-centric funds.

The CFA Institute has emphasised the importance of common approaches or principles in how sustainable funds are marketed and managed globally. To this end, the International Organisation of Securities Commissions has published recommendations on sustainability-related practices, policies, procedures and disclosures in the asset management industry for use by member regulators.

As different jurisdictions follow the path pioneered by Europe’s SFDR, it is almost inevitable that requirements will vary in the short term. The UK’s Financial Services Authority published a discussion paper on its new classification and labelling system for sustainable investment products in November, and expects to conduct a further consultation in Q2 2022.

Hong Kong’s Securities and Futures Commission (SFC) provided updated guidance to asset managers detailing enhanced disclosure requirements for funds which incorporate ESG factors in Q2 2021. The Securities and Exchange Board of India (SEBI) launched a consultation on new requirements for ESG-labelled mutual funds, proposing more granular disclosures last October. The Monetary Authority of Singapore (MAS) is expected to introduce new guidelines on ESG funds to prevent guidelines, following a speech last month by Tan Keng Heng, executive director of MAS.

The United States is due to unveil new sustainable fund-labelling requirements later this year, but the US Securities and Exchange Commission’s regulatory agenda is being held up by rows over its plans for mandatory climate disclosures.


The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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