INSIGHT by the Institute for Energy Economics and Financial Analysis (IEEFA)
〉Failings of SFDR stem from a disconnect between its intended use as a system for identifying fund disclosure levels and its widespread adoption as an ESG labelling mechanism.
〉Two approaches for reshaping SFDR have emerged, but only by replacing the current article system with one that is applied uniformly to all products can transparency truly be improved.
〉By adopting a labelling system that overlaps with similar proposals from the UK’s Financial Conduct Authority, the industry can limit compliance burden and asset owner confusion.
〉Some asset managers should already be looking to tighten practices ahead of regulatory course correction.
The European Union’s Sustainable Finance Disclosure Regulation (SFDR) should move to a labelling regime in response to industry concerns that the current format is failing to achieve stated transparency goals.
A new report from the Institute for Energy Economics and Financial Analysis (IEEFA) suggests that such a system should involve applying sustainability reporting requirements consistently to all funds, removing the need for current article distinctions.
Introduced in March 2021, SFDR mainly targets asset managers and requires the publication of environmental, social and governance (ESG) credentials at product and entity levels. It may be overhauled following an ongoing consultation by the European Commission that aims to assess the regulation’s shortcomings and ability to tackle greenwashing.
SFDR currently relies on a system of categorisation, whereby a fund must be qualified as Article 9, 8 or 6 by an asset manager. The higher the categorisation, the higher the sustainability-related disclosure levels. This process aims to force asset managers to be transparent about how deeply sustainability issues are integrated into investment practices and to disclose appropriately, allowing asset owners to make informed investment decisions.
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However, cracks in the SFDR system have become increasingly obvious. These stem from a disconnect between its intended use as a system for identifying appropriate fund disclosure levels and its adoption as a de-facto ESG labelling mechanism, used by managers to signal the sustainability ambition of products. Vague definitions and managerial agency over the SFDR categorisation process have led to a damaging lack of consistency in application. This is particularly true of Article 8 funds where sustainability ambition varies widely.
“SFDR has increasingly come under fire for not achieving its transparency goals. This far-reaching consultation shows that standard setters have been listening and presents an opportunity to rework an unfair and confusing article categorisation system.”
-Alasdair Docherty, author of the report and a sustainable finance and data analyst at IEEFA
Based on the consultation, there are two prevailing trains of thought as to the future shape of SFDR: Keep the article definitions as they are, but apply minimum standards for Articles 8 and 9, or scrap article levels and switch to a system of labelling.
While both options would improve on the current system, IEEFA’s preferred approach of introducing a labelling system would enhance transparency and end a system of article naming that is confusing for retail audiences.
Furthermore, by adopting a labelling system that overlaps with similar proposals from the UK’s Financial Conduct Authority, the report finds that industry could move closer to a harmonised approach across jurisdictions, leading to reduced compliance burden and asset owner confusion.
“Despite transparency problems, recent outflows tell us that asset owners have woken up to the fact that simply being called Article 8 isn’t a guarantee of sustainability ambition,” said Docherty. “With regulatory course correction looming and assets already deserting funds without minimum sustainable investment commitments, voluntarily applying robust minimum standards should be a priority for asset managers.”
Explore the report
SFDR’s Early-Life Crisis Presents an Opportunity to Level the Playing Field
| All opinions expressed are those of the author and/or quoted sources. investESG.eu is an independent and neutral platform dedicated to generating debate around ESG investing topics.
