Battle lines are drawn over the future of SFDR

Market participants disagree on future fund labelling system but mainly back disclosures for all funds, eliminating entity-level PAIs.

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Investors, market participants and industry bodies have set out their opinions on the future of the EU’s Sustainable Finance Disclosure Regulation (SFDR) ahead of a wide-ranging consultation on potential reforms closing at the end of the month.

The consultation had been due to close on Friday but was yesterday delayed by a week to give respondents more time to answer.

In September, the European Commission released a wide-ranging consultation on the future of SFDR. The 44-page questionnaire covers a series of topics including changes to disclosure requirements and whether the purpose of the regulation itself is still relevant.

While the consultation covers many fundamental aspects of the regulation, one of the key questions is the ultimate fate of Articles 6, 8 and 9. While originally intended as disclosure standards, the absence of an alternative labelling system has led to them becoming de-facto fund categories.

Market participants, especially managers who have spent considerable time and money on compliance with the existing SFDR, are torn between tearing up many of the rules and starting again in order to ensure a working regulation, and ensuring that their current efforts are not wasted.

The EU’s own industry expert group – the EU Platform on Sustainable Finance – said in its final report that there was significant reluctance among financial market participants to abolish Articles 8 and 9 as it may entail substantial changes and costs.

The influential group said it supported the wish to use as much of the existing system as “sensibly possible”.

Responses to the consultation seen by Responsible Investor universally call for some kind of labelling system, with many approving of a framework proposed by the Commission that broadly mirrors that of the UK and would involve the abolition of Articles 6, 8 and 9 altogether.

Morningstar used perhaps the strongest language of respondents, calling for the “eradication” of the Article distinction and its replacement with descriptive categories with 70 percent thresholds for investments. It also called for the definition of sustainable investments for transition and focus funds to be taxonomy-aligned.

The taxonomy alignment approach was also echoed by the Platform’s report, which said that the definition of environmentally sustainable investments should be exclusively derived from the EU taxonomy, except for areas not yet covered.

Other respondents to back abolition include the Dutch financial regulator AFM, Robeco, think thank the Institute for Energy Economics and Financial Analysis, and industry body ICI Global.

ICI Global advocated for a less stringent approach to the system than some respondents, calling for a future category system to not have any restrictions on fund naming, and opposing any quantitative minimum criteria for categories.

In looking for an alternative, some firms backed the approach proposed by the Commission, which would broadly mirror the UK’s approach with three labels for impact, transition and sustainability-focused funds, as well as a fourth label for exclusions-orientated funds.

Jenn-Hui Tan, chief sustainability officer at Fidelity International, tells RI that his firm backed the three-label system, with the addition of an “ESG tilt” label for funds with a “medium sustainability intensity” such as a best-in-class strategy.

This was echoed by Robeco. Carola van Lamoen, its head of sustainable investing, wrote in a cover letter to the firm’s response that it endorsed an impact, transition and sustainable focus label, warning that it was “critical” to ensure international interoperability.

There was also broad support for introducing a mixed label for funds that covered multiple strategies to align with the UK approach, while some firms also opposed introducing the basic label for exclusions funds. Morningstar, for instance, said it saw “limited value” in such a label.

Hope for 8 and 9?

Other respondents either did not take a stand or were reluctant to let go of Articles 8 and 9.

Elise Beaufils, deputy head of sustainability research at Lombard Odier Investment Managers, summed up the argument for keeping the framework based on the current system.

“While a focus on clarity and precision should be appreciated and encouraged, especially regarding sustainable investment,” she told RI, “a radical shift towards a different category labelling approach within the SFDR regime would be counterproductive. It risks exacerbating regulatory uncertainties and opening long cycles of consultations and iterations instead of building from the past three years’ experience.”

BNP Paribas Asset Management has previously said it backed reform to the existing system rather than wholesale replacement. A spokesperson told RI that it backed a clear set of product categories with binding minimum criteria that would inform investors “how demanding they can expect a financial product to be”.

Fellow French manager Mirova also took this attitude, warning that any new approach could risk causing greater uncertainty. Formalising Articles 8 and 9 as fund categories with minimum standards and better supporting the idea of sustainable investments with a social and comprehensive green and brown taxonomies, as well as formalising the concept of transition investments within SFDR would be a better way forward, it said.

Some industry bodies remained on the fence.

The International Capital Markets Association said that there was significant divergence in the views of its stakeholders on which approach to take. “We therefore support a blended approach that introduces clear labels based on investment objective and intentions, while leveraging at maximum existing processes that have been difficult and costly to implement,” it said.

Similarly Germany’s SIF, the Forum Nachhaltige Geldanlagen , did not put its weight behind either option. Instead, it set out a series of principles for any future approach including clear minimum standards, avoiding a hierarchical approach when it comes to transition and impact investments, and ensuring the framework is applicable to all asset classes and not just equities.

A time of innovation

Other respondents proposed their own systems for fund classification.

While the EU Platform did not specifically endorse any one approach, it suggested that a hybrid of Articles 8 and 9 disclosures and a descriptive labelling system for retail investors could be the solution.

This approach was also backed by Frédéric Vonner, sustainable finance and sustainability leader at PwC Luxembourg, who warned against drastic changes given the effort already put in by firms to comply. Complementing Article 8 and 9 disclosures with actual labels, as well as implementing minimum sustainable investment thresholds for the Article categories, would be a positive development, he said.

Finans Danmark – Denmark’s financial industry body – proposed a three-tier system. Funds currently falling under Article 9 would get to be classified as Sustainable Investments, while funds with sustainability-related objectives would be pulled into a Responsible Investments category alongside Paris-aligned and Climate Transition Benchmark funds. The third category would contain “basic” responsible investment funds with standard exclusions.

Triodos Investment Management proposed a five-tier system, with funds ranked based on their PAI disclosures and minimum sustainable investment shares. It said that category names should be based on numbers or letters to avoid having to relabel categories if the meaning of terms changes over time.

It added that both a reformed 8/9 system and the mirrored SDR framework were “insufficient” as they do not allow for comparability and do not address “greenhushing” as they only look at sustainable products.

Meanwhile, a spokesperson for Amundi told RI that it had suggested a number of categories, including “contribution”, “transition” and “generic focus on environmental and/or social objective”. It said that any approach should leverage existing national labels as well as EU climate benchmarks.

PAI principles

Another controversial topic relates to how and which funds should be required to disclose sustainability-related information. Many participants back making all funds disclose a minimum level of sustainability information but this approach is by no means universal.

Elise Attal, head of EU policy at the PRI, told RI that the group backed a baseline of sustainability disclosures for all products. “This would contribute to creating a level playing field regarding sustainability reporting obligations and increase comparability across financial products in the EU,” she said.

This approach was also backed by Amundi, the FNG and Fidelity International, which called for baseline mandatory disclosures for all products, but said there should be additional disclosures for funds adopting a sustainability label.

Some were in favour of streamlining the system. Finans Danmark said that if uniform disclosures were introduced, these should cover only the most basic and understandable principal adverse impact (PAI) indicators, while Robeco called for better alignment between the materiality-based disclosures under the Corporate Sustainability Reporting Directive (CSRD) and the mandatory ones that asset managers are subject to.

ICI Global, however, opposed the idea. It said that mandatory disclosures for all funds would run the risk of raising costs across all EU products, would result in irrelevant and confusing information for investors, and disclosure obligations should be clearly related to a product’s investment strategy.

Respondents were also generally critical of entity-level reporting requirements under SFDR, particularly PAI disclosures, and many backed switching these requirements to firms’ CSRD reporting obligations.

Finans Danmark warned that while entity-level PAI statements were useful for internal purposes, the lack of comparability and ability to easily game the numbers made them less useful for external observers. Amundi backed keeping some entity-level disclosures but with simplifications.

Triodos IM called for their removal entirely, with entity-level disclosures to be based on the CSRD instead, while ICI Global said it “strongly recommends eliminating” the disclosures.

The Platform suggested a similar system to Triodos, recommending an assessment of whether PAI disclosures at an entity level could be integrated into CSRD reporting for financial market participants.