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SFDR II Must Deliver “Simplicity”

Dutch regulator proposes overhaul ahead of green fund consultation closure; France follows Belgium in revising SRI label to exclude fossil fuel developers. 

Industry experts have stressed the need for simplicity and clarity around Europe’s ESG fund labelling, as the European Commission’s Sustainable Finance Disclosure Regulation (SFDR) consultation deadline looms.  

Regulators around Europe have been increasingly active this month, coming out with new requirements and proposals that could reshape the sustainable investment landscape in Europe.  

On 14 September, the Commission published a long-anticipated consultation, seeking feedback on the current requirements of SFDR, its interactions with other sustainable finance legislation, and potential changes to disclosure requirements for financial market participants. 

A key objective of the targeted consultation is to get input from public bodies and stakeholders to assess SFDR’s potential shortcomings. 

“The main word here is clarity,” Pierre Garrault, Senior Policy Advisor at the European Sustainable Investment Forum (Eurosif), told ESG Investor. “Ever since SFDR was introduced, there has been the demand for more clarity and legal certainty.” 

Speaking to ESG Investor, Hortense Bioy, Global Director of Sustainability Research at data and analytics provider Morningstar, agreed that investors want “clarity, simplicity, and minimum safeguards”. 

The SFDR consultation is due to close on 15 December.  

Strengthening SFDR 

In its current iteration, SFDR requires financial service providers, including asset managers, to disclose detailed information about products marketed as mitigating ESG risks or having sustainability characteristics or objectives.  

However, Garrault noted that SFDR has increasingly become thought of as a categorisation regime instead of a disclosure framework as originally intended. 

He added that the consultation is “pretty wide reaching” and could lead to “a lot of different outcomes depending on the responses and what the Commission wants to do with it”. 

According to Garrault, a key objective is to identify whether the Commission should formalise product categories within the SFDR framework.   

“If categories are established, they should be based on specific objectives, backed by precise criteria and also be accompanied by disclosure requirements that would be tailored to the different types of products,” he added.  

“Minimum sustainability disclosure requirements should also apply to all financial products.” 

Bioy said that the two biggest issues with SFDR in its current form are its “complexity and lack of minimum standards, especially for Article 8.” 

Article 8 funds promote “environmental and/or social characteristics”, provided that companies in which the investments are made follow good governance practices.  

Article 9 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”. Article 6 covers funds that do not integrate any kind of sustainability into the investment process.   

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

Sustainable improvers inclusion 

Lara Cuvelier, Sustainable Investments Campaigner at environmental non-profit Reclaim Finance, told ESG Investor that sustainable funds in general “desperately” need minimum criteria due to the current market being “far from self-disciplined”. 

A proposal was made by the Dutch Authority for Financial Markets (AFM) earlier this month. The regulator suggested the current SFDR framework could be improved by discarding the current Article 8/Article 9 distinction and replacing them with three categories – transition, sustainable, and sustainable impact.  

These categories mirror the three product labels proposed by the UK’s Financial Conduct Authority (FCA) last year as part of its Sustainability Disclosure Requirements (SDRs) which aim to crack down on greenwashing. The SDRs were due to be introduced on 30 June, but following various delays are now expected in H2 2024. 

In the AFM’s proposal, the ‘transition’ category products aim to create impact by active management of investment in companies that are not yet sustainable, but plan to become so. ‘Sustainable’ category products aim to invest in assets that are already sustainable, while ‘sustainable impact’ products look to create impact through investment in companies with a positive impact on sustainability factors. 

Other products with sustainability characteristics should disclose these, but would not be allowed to be marketed as sustainable.  

The consultation has identified two possible strategies to transition the existing SFDR framework to a more precise product categorisation system. 

The first would build on and better develop the distinctions between Articles 8 and 9, while the second would introduce a product categorisation system focused on the type of investment strategy, such as transition focus or promised contributions to certain environmental objectives. 

Bioy said the AFM recognises that the current scheme is “too complex and leaves too much room for interpretation”. 

“In the sense that it tries to address these issues, we believe that the AFM proposal goes in the right general direction,” Eurosif’s Garrault said.   

Cuvelier said the proposition lacks an explicit statement on minimum requirements for sustainable products.  

“I still see a danger of letting the market regulate itself,” she added. 

Bioy shared similar concerns, noting that it is unclear how a labelling regime will improve comparability.  

“To make a product directly comparable, you need benchmarks or a standard definition of sustainable investment, which is not what’s being proposed,” she added. 

Bioy also noted that “more voices seem to be supporting a labelling regime”, including the European Securities and Markets Authority (ESMA). 

ESMA recently warned on the “misleading” use of ESG-related terms by funds, as research by the European regulator highlighted how ESG-related named funds attract more inflows, raising concerns about potential greenwashing. 

Sending a strong SRI signal 

Last week, French Minister of the Economy Bruno Le Maire announced that eligibility for its revised Socially Responsible Investment (SRI) label will exclude companies that exploit coal or non-conventional hydrocarbons, as well as those that launch new projects to explore, exploit or refine oil and gas reserves. The label will also require a transition plan aligned with the Paris Agreement. 

This follows updates to the criteria of a similar SRI label by Belgium in July. The revised criteria stated that investee energy companies cannot be involved in the exploration, exploitation or development of new oil or gas fields, nor the building new coal-fired power stations. 

The final criteria for the new SRI label is set to be published by the end of November and will come into effect from 1 March 2024. In France, there are currently 1,174 funds with the SRI label worth a total €773 billion (US$826 billion). 

Oil and gas giants including BP, ENI and TotalEnergies are expected to be excluded under the SRI label new guidelines. 

According to the United Nations Development Programme’s (UNDP) recently published 2023 Production Gap Report, governments plan to produce as much as 110% more fossil fuels in 2030 than would be consistent with limiting warming to 1.5°C, and 69% more than would be consistent with 2°C.  

“I really see growing consensus with this very clear criteria on fossil fuels,” Cuvelier said.  

“It’s hard to tell if the European regulators will also implement these minimum requirements under SFDR anytime soon, but it feels like they’re going to have to at some point if they want to remain credible on sustainable finance regulation. 

“The French market we very much welcome this clear stance from the government – It’s a very strong signal,” she added.  

Last month, Reclaim Finance signed an open letter that called on French Prime Minister Elisabeth Borne to exclude companies involved in new fossil fuel projects from the French SRI label. 

Article 9 ambitions 

On 1 January, Level 2 of SFDR came into force requiring asset managers to provide more detailed disclosures to justify Article 8/Article 9 categorisations. Heightened concerns about greenwashing accusations due to ongoing confusion around Level 2 rules prompted asset managers to downgrade 350 Article 9 funds to Article 8 in H2 2022. 

In October, Morningstar found that Article 9 funds had hit a “new low” attracting just €1.4 billion over the past three months. It also highlighted that a third of Article 8 funds target no sustainable investments and only 28% of Article 9 funds plan to make taxonomy-aligned investments.  

“I wouldn’t say it’s necessarily bad news that the AUM in Article 9 is lower now,” Cuvelier said. “If it was higher, but with a lot of greenwashing and a lack of strong criteria, then it wouldn’t mean anything.” 

She added that asset managers had previously been “a bit quick” and “not careful enough” in classifying funds as Article 9.  

There are currently around 1,000 Article 9 fund categories, representing about 3.7% of all funds distributed in the EU. 

A survey carried out by Morningstar Sustainalytics revealed a split in market participant perspectives on future of Article 8 and Article 9 funds. Half of respondents said they would like to see these classifications replaced by labels, 39% would prefer to keep Article 8 and Article 9 but introduce minimum standards, and 7% voted for the status quo. 

“Asset managers are waiting for more clarity from regulators,” Cuvelier noted. “That’s why it’s very important that regulators start giving more strict rules.” 

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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