Managers’ Eyes on SFDR Prize

EC maps out the final hard yards for the sustainable funds’ regime. 

Although the journey has been fraught with confusion and delays, the second part of the EU’s Sustainable Finance Disclosure Regulation (SFDR) – widely known as Level 2 – has reached the home straight. 

On 6 April, the European Commission adopted SFDR’s Regulatory Technical Standards (RTSs) under a single delegated regulation (DR). 

“The Commission has finally given us clarity on the general orientation of the RTSs,” says Victor van Hoorn, Executive Director of the European Sustainable Investment Forum (Eurosif). 

Essentially, the RTSs for SFDR Level 2 ask fund providers for more detail, including on their carbon emissions. Asset managers will be expected to justify labelling their EU-domiciled funds as ‘ESG’ or ‘sustainable’ through a series of environmental and social indicators and principal adverse impact (PAI) disclosures. Under the RTSs, asset managers will also be expected to further disclose their funds’ level of alignment with the EU Taxonomy Regulation’s list of environmentally sustainable activities. 

This follows SFDR Level 1, which came into effect over a year ago, and has required asset managers to sort their investment products into three categories: Article 6 (not sustainable), Article 8 (sustainable characteristics) and Article 9 (sustainable objectives).  

Combined, the regulation is designed to help European asset owners understand, compare and measure the sustainability characteristics of investment funds, limiting their exposure to greenwashing. 

“We are in a rather odd situation, where the so-called Level 1 is already enforced and in application, but we haven’t yet enacted the detailed regulations for the specific disclosures that are required,” acknowledged Alain Deckers, European Commission Directorate-General for Financial Stability, Financial Services and Capital Markets Union (DG FISMA), speaking on a recent Man Group podcast. 

But categorising funds into Article 6, 8 or 9 has already had “ramifications far beyond the EU”, van Hoorn tells ESG Investor.  

“SFDR is already shaping the market,” he says. “It has been a catalyst for placing sustainability at the heart of the organisational agenda of many asset managers and asset owners.” 

The European Council and Parliament now have three months (which can be extended by an additional three months) to scrutinise the DR. Provided there are no further delays, the RTSs will be published in the Official Journal of the EU and will be scheduled to apply from 1 January, 2023.  

The finalised DR document outlines all 13 RTSs and provides an explanatory memorandum. Further, it includes templates for a principal adverse sustainability impacts statement, pre-contractual disclosure documents for Article 8 and 9 funds, and periodic disclosure documents for Article 8 and 9 funds. 

Many of the changes have been marked as “non-substantive” by industry experts, meaning that asset managers that “began preparing in earnest to report based on the draft standards will have got a good start, while those who delayed may feel they’ve lost some useful time,” says Kirstene Baillie, Finance Partner at law firm Fieldfisher. 

As always, some questions still remain that policymakers will need to address over the ensuing months. Nonetheless, asset managers and other service providers shouldn’t wait for perfection before complying. 


New changes that have been made to the RTSs presented by the European Supervisory Authorities (ESAs) last year have attempted to streamline disclosure requirements for investors.  

“Given that the implementation and reporting deadlines are fast approaching, the lack of substantive change is on the whole welcome as the goalposts have remained more or less where they were,” says Baillie. 

That’s not to say asset managers can relax. 

As well as demonstrating how fund products are contributing – and will continue to contribute – positively to listed environmental and social indicators, asset managers are expected to report how their funds will reduce their exposure to the principal adverse impacts of their underlying investments.  

PAIs include destruction of biodiversity, carbon footprint and exposure to companies active in the fossil fuel sector.  

Crucially, Scope 3 greenhouse gas emissions are now included in the PAIs, following an update the framework recommended by the Task Force on Climate-related Financial Disclosures. Asset owners have previously cited the challenges of accounting for Scope 3, due to shortcomings in data. 

Another of the changes that has been made in the DR is that the waste PAI has been updated to include radioactive waste, meaning that managers will have to disclose the tonnes of hazardous and radioactive waste generated by investee companies per million euros invested (expressed as a weighted average). 

Under the finalised regulation, fund providers are further required to outline future plans to reduce their exposure to biodiversity destruction or production of radioactive waste, for example, thus allowing for asset owners to weigh a fund’s actual progress against the asset manager’s stated ambitions.  

In instances where information on a PAI is not readily available, the Commission noted that managers must include details of their “best efforts” to obtain this data, including engaging with investee companies, carrying out additional research, cooperating with third-party data providers or “making reasonable assumptions”.  

Meeting new targets 

Last year, the ESAs developed additional RTSs that would require asset managers with Article 8 and 9 funds to disclose their degree of alignment with the Taxonomy Regulation’s environmental objectives. The environmental taxonomy serves as a classification system for investors, outlining which economic activities will be considered sustainable in the EU. 

The newly finalised DR has confirmed that asset managers will need to identify which taxonomy-listed activities their funds are contributing to, and to what extent. For example, under the taxonomy’s Climate Delegated Act – which came into force in January – investing in energy efficiency measures for built environments is considered a sustainable economic activity. This can include deployment of on-site renewable energy, building renovation, and the development of energy efficiency equipment. SFDR-labelled funds investing in these areas can therefore highlight alignment with this particular objective of the taxonomy.  

Demonstrating taxonomy-alignment will not apply to Article 8 and 9 social-focused funds, however, but may be required in the future if the final proposal for a social taxonomy is carried forward. 

“The taxonomy still only covers a smaller part of the economy, and therefore investment portfolios. Taxonomy-alignment RTSs will only [require managers to] provide information about part of the portfolio,” Eurosif’s van Hoorn points out.  

The DR has confirmed that sustainable investments made by Article 8 and 9 funds can contribute to environmental objectives not currently set out in the Taxonomy Regulation. As the technical screening criteria for the four remaining environmental objectives of the taxonomy are finalised, there is opportunity for an increasing percentage of sustainable investments made by SFDR-labelled funds to align with the taxonomy. The four remaining objectives are: sustainable use and protection of water and marine resources, transition to a circular economy, pollution prevention and control, and protection and restoration of biodiversity. 

The final DR also confirmed the draft’s recommendation that Article 8 and 9 funds comply with the taxonomy’s ‘do no significant harm’ and minimum safeguards criteria, meaning that asset managers’ due diligence procedures will need to measure alignment with international social standards, such as the UN Guiding Principles on Business and Human Rights. 

Further clarification for asset managers with Article 9-labelled funds was also forthcoming.  

The DR stated that Article 9 products should make sustainable investments only, other than cash held as ancillary liquidity or hedging instruments, according to James Tinworth, Funds Partner at Fieldfisher.  

He adds that instruments for which sustainability data is “lacking” will not be accepted as Article 9 products. 

“Confusingly, Recital 15 [of the DR] also states that Article 9 products ‘can to some extent make other investments where they are required to do so under sector specific rules’, without giving any guidance on what this actually means,” Tinworth tells ESG Investor 

Keeping up the pace 

As with any piece of regulation under development, questions remain.  

One such concern centres around the availability of consistent, comparable and reliable ESG-related data to inform SFDR disclosures.  

“Many [asset managers] are likely to rely on data solutions offered by third-party vendors to comply with regulatory obligations, such as the PAIs under SFDR,” says van Hoorn.  

“The problem is that [Eurosif] is getting reports highlighting big variations and discrepancies in data from different data providers for the same portfolios and companies. This does therefore raise questions about the accuracy of available data for the foreseeable future.”  

As SFDR is rolled out, van Hoorn predicts that industry and policymakers will be turning their attention to the role data vendors are playing in the market.  

The inconsistencies in ratings and scores are often the result of limited company disclosures forcing vendors to make educated estimates according to their in-house methodologies.  

The EU’s Corporate Sustainability Reporting Directive (CSRD), which will replace the Non-Financial Reporting Directive and also introduce the European sustainability reporting standards (ESRSs), will help to “improve the availability of data for the EU investable universe”, says van Hoorn. In turn, this will help to inform the data needed for asset managers complying with SFDR. 

“But it will have limits in that many funds and managers subject to SFDR invest a large share of their AUM outside the EU,” warns van Hoorn. “So CSRD will help, but it will not be the silver bullet for globally operating investors.”  

There are also questions about what purpose SFDR is meant to serve. 

In a speech last month, Natasha Cazenave, Executive Director of the European Securities and Markets Authority (ESMA), acknowledged that fund managers and investors are increasingly treating SFDR’s disclosure categories as a product classification tool. 

DG FISMA’s Deckers is concerned about this increasing propensity to treat SFDR as a “de facto product labelling scheme” instead of a transparency framework.  

“SFDR isn’t a product labelling scheme,” he said. “Claiming or suggesting that is 100% misleading.” 

Van Hoorn says that a fundamental discussion needs to be had about the role SFDR is expected to play in the EU market. 

“The question we need to ask is: Do we want to keep SDFR as a broad-based transparency framework, or do we want at some point to evolve SFDR towards being a minimum standard or label?” he says.  

Deckers pointed out the Commission plans to look into the development of product labelling or standards, “in particular in relation to Article 8 products”. 

It remains to be seen whether this will be a separate piece of legislation or an extension of SFDR.  

In ESMA’s Sustainable Finance Roadmap 2022-24, the securities regulator noted it will contribute to the Commission’s planned work on minimum sustainability criteria, or a combination of criteria for financial products that disclose under Article 8 of SFDR. 

“There may be areas where we need to provide further tools to the industry. There may be areas where we may need to take further action, if we notice that there is a real risk and reality of greenwashing. There may be areas where we need to act […] let’s see how things pan out,” said Deckers. 

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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