SFDR: Market Divided on Future of Article 8, 9 Funds

Market participants flag importance of double materiality to enhance Article 8/9 definition alignment, stress need to recognise transition strategies. 

Responses to the European Commission’s Sustainable Finance Disclosure Regulation (SFDR) consultation largely support improved definitions for green funds but are split on whether to junk existing labels.  

In a joint response, Impact Europe – formerly the European Venture Philanthropy Association – said information required under SFDR must be comparable, understandable, accurate, easy to find and “appropriate” for investors. 

Pierre Garrault, Senior Policy Advisor at the European Sustainable Investment Forum (Eurosif), told ESG Investor that while SFDR has improved transparency on integrating sustainability risks it requires review to “build on its achievements and ensure it is fit for purpose”.  

Introduced on March 2021, SFDR outlines disclosure requirements for asset managers and other financial service providers regarding the sustainability profiles of financial products, and has been widely used as a classification system for ‘green’ investment products.  

In September, the Commission published a long-anticipated consultation, seeking feedback on the current requirements of SFDR. It also identified two possible strategies for transitioning 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. 

Article 8 funds promote “environmental and/or social characteristics”, while 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”. 

Risk of uncertainty 

French asset manager Mirova’s response said the current definition of Article 8 products is “too broad”, while the definition of Article 9 is “too narrow”. The Platform on Sustainable Finance, which advises the Commission on sustainable finance policy, noted that Article 8 funds are “hard to categorise”, encompassing of a “wide range” of strategies and sustainable investment approaches. 

However, it suggested formalising Articles 8 and 9 as product categories and establishing “clear and specific criteria” rather than instituting an overhaul that risks “creating uncertainty” in the market.  

It also said the definition of sustainable investment need not change as it already includes the “fundamental concepts” of positive contribution, do no significant harm, and good governance. 

Other respondents were more in favour of change, including the UK Sustainable Investment Forum (UKSIF), which saw merit in developing “a distinct, voluntary product classification system” within the SFDR, potentially aligned to the UK’s Sustainability Disclosure Requirements. 

“We would very much welcome a marked shift from reliance on Articles 8 and 9 as de-facto fund labels in the market, which has contributed to greenwashing risks for end investors,” said UKSIF Chief Executive James Alexander in the organisation’s consultation response.  

This split in opinion was showcased in a Morningstar Sustainalytics survey, in which 50% of respondents said they would like to see Article 8 and Article 9 categories replaced by labels, while 39% would prefer to keep Article 8 and Article 9 categories. 

According to Morningstar’s SFDR Article 8 and Article 9 Funds Q3 2023 Review, Article 8 and 9 fund assets are worth more than €5 trillion (US$5.8 trillion) with Article 8 accounting for 53% of the market.  

In Q3 2023, newly incepted Article 8 and Article 9 funds accounted for half of total funds launched in the EU. 

Eurosif’s Garrault agreed that SFDR is currently “insufficiently clear” on some key concept definitions and its use as a de-facto classification regime leaves “room for interpretation” which risks “fragmented implementation” and raises investor protection concerns. 

Mirova also suggested further embedding double materiality in SFDR to enhance alignment of Article 8 and 9 definitions. 

“Although double materiality is already present in SFDR notably with the concepts ‘sustainability risks’ and ‘adverse sustainability impacts’, ESG product classification should only be applied to funds implementing double materiality,” it added. 

Impact Europe’s consultation response recommended that mandatory disclosure requirements “should adhere to the double materiality principle”. 

Targeting transition 

The consultation also asked whether the current SFDR framework effectively captures transition asset investments, as well as proposing a category for products with a “transition focus”. 

UKSIF’s Alexander underscored a “critical” need to more clearly recognise transition strategies and investments in the SFDR, stressing their importance for an economy-wide net zero transition. 

A proposal made by the Dutch Authority for Financial Markets last month suggested the current SFDR framework could be improved by discarding the current Article 8/Article 9 distinction and replacing them with three categories.   

This included a ‘transition’ category aiming to create impact through the active management of investment in companies that are not yet sustainable, but plan to become so. 

These categories mirror the three product labels proposed under SDR by the UK’s Financial Conduct Authority, recently supplemented by a fourth. 

Mirova also supported the introduction of transition investment into SFDR. It said that Article 9 funds should “remain largely composed of sustainable investments”, while Article 8 funds could encompass a “significant proportion of transition investments”. 

The International Capital Market Association said it “strongly” supports a transition-focused label, noting that the current SFDR regime is “not perceived” to be sufficiently incorporating transition. However, it added clear minimum criteria and standards should accompany this label to “maintain credibility and avoid controversy”. 

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