EU publishes long-awaited fund disclosure rules to curb greenwash  

The European Commission (EC) has adopted its landmark fund-level sustainability disclosure rules almost two years to the day the first draft of the anti-greenwash regulations was released for public feedback. 

The rules flesh out the technical requirements and criteria that EU fund managers will need to comply with when reporting the sustainability performance of their products under the EU’s overarching Regulation on sustainability-related disclosures in the financial services sector (SFDR). 

It is hoped that the disclosures will support investor decision-making by providing a clearer picture of the extent to which all investment products, not just those branded as ESG, contribute toward “adverse impacts” on broader social and environmental goals. 

From 2023 onwards, managers will have to report against 18 mandatory sustainability indicators, a dramatic reduction from the 32 proposed in the first draft. Most of the indicators lost in the overhaul are social-based, including those around corruption, forced labour and human trafficking.  

The final list comprises 14 general indicators (nine environmental and five social), two indicators for sovereigns investments (one environmental, one social) and two indicators for real estate investments (both environmental). 

In addition, managers must specify their engagement policies and disclose their adherence to relevant international guidelines such as the OECD Guidance for Responsible Business Conduct and the International Labour Organisation conventions on workers’ rights.  

The Commission has separately outlined an additional 22 environmental and 24 social indicators for voluntary disclosure. Providers will be expected to disclose against at least one in each category based on their materiality to a fund’s strategy. 

The rules are set to be applied on a comply-or-explain basis. Managers who do not consider adverse impacts will be required to provide justification via a public statement covering the most recent calendar year. 

The EU’s co-legislative bodies, comprising member states represented by the EU Council and Parliament, will now have four months to veto the SFDR rules – known as Regulatory Technical Standards (RTS) – before they automatically come into force.  

Heated opposition

The adoption of the RTS follows a period of heated opposition to the initial draft, which was branded as unfeasible, costly and irrelevant to investors. Critics focused on a supposed shortfall of available and credible data on the proposed indicators, with CDP, MSCI and State Street Global Advisors among those suggesting that providers would struggle to find information relating to water emissions, corporate policies on human trafficking, and emissions of ozone-depleting substances, among others 

The proposals also found limited support among responsible investing bodies. Eurosif and Principles for Responsible Investment (PRI) described the rules as providing “little context and too much information to investors” and “not fit for purpose” respectively in separate submissions to the Commission. 

By contrast, the proposed legislation was championed by shareholder pressure groups such as Global Witness and ShareAction. The latter argued that a fixation on “financial materiality” had caused investors to ignore their contribution to systemic risks such as forced or child labour, water pollution and deforestation, and that this would be further exacerbated by weak disclosure rules. 

The feedback prompted a revision of the draft rules and a subsequent delay of the initial planned SFDR implementation date of March 2021. 

Large parts of the SFDR have already entered into force, but the required disclosures have so far been “principles-based”, meaning firms can decide the scope of reported information based on factors they consider to be material to investor decision-making.  

Since March 2021, firms have been asked to show how sustainability considerations have been integrated at both corporate and product level, in addition to disclosing the extent to which their investment activities have resulted in harmful effects or “adverse impacts”. 

But the SFDR provision making the most headlines has been a requirement for fund companies to classify their products according to their sustainability objectives. Article 9 funds must have an exclusive focus on sustainability. Article 8 can combine traditional investment objectives with ESG considerations. Non-ESG funds are categorised as Article 6. 

While the EU has not set minimum performance thresholds for the categories – it has stressed that the requirements are a disclosure initiative and not a fund label – recent fund data shows the EU ESG fund market contracting by $2 trillion as fund companies revised their product branding following the introduction of the rules. 

Data providers have followed suit, with Morningstar recently culling more than 1,200 funds with around $1.2 trillion in assets from its European sustainable funds database.