It has been two years since the implementation of the SFDR (Sustainable Finance Disclosure Regulation) by the European Commission (EC). To gauge its efficacy, and understand the difficulties and consequences on financial market participants, the EC recently circulated a consultation paper seeking feedback on its implementation and the core concepts underpinning it (consultation running until 15 December 2023).
The Cority team attended a webinar hosted by the EC on this consultation paper and is able to share some insights.
Consensus from Financial Market Participants
- Sustainability is no longer a niche topic, it has arrived at the board: There’s a noticeable shift, with both companies and investors placing increased importance on sustainability.
- More and more information on sustainability is circulating: the streamlining of disclosure requirements (through the RTS precontractual and periodic disclosure templates) and the use of PAIs (Principal Adverse Impacts) indicators serve as crucial tools for enhancing transparency. As a result, an increasing amount of data and information on sustainability is publicly.
- A de facto labeling system emerged: Both the EC and major European stakeholders (such as the EU’s Platform on Sustainable Finance or ESMA) concur that the SFDR has had some unintended consequences. Participants agree that it has evolved into a de facto labeling system, but one which doesn’t necessarily guarantee tangible and meaningful information to investors about genuine sustainability performance of financial products.
- Greenwashing concerns persist: The somewhat ambiguous nature of the SFDR terms such as “Sustainable Investment” or “Good Governance Practices” have led financial market participants to interpret the regulation differently. This has led to diverging disclosures practices and, inadvertently, the risk of greenwashing has increased.
- Capacities to understand disclosure requirements diverge: The statement shared by Hadewych Kuiper, Commercial Director at Triodos Investment “Completing the SFDR documents is like trying to fit a square peg into a round hole” succinctly captures the sentiment: understanding the regulatory requirements (including their links with other regulations such as the taxonomy) and identifying the necessary information to be disclosed, is not a self-explanatory task. Unfortunately, the complexity means that not everyone, especially not retail investors, who may have neither the resources nor the time to acquire such expertise, can understand the disclosures.
Proposed Changes for SFDR Regulation Review
- Universal Sustainability Disclosures: There’s a growing voice advocating for a certain level of sustainability disclosures to be a staple for all financial products, whether they invest sustainably or not. In other words, funds seeking to invest sustainably should not be overly burdened with disclosure requirements compared to traditional funds.
- Refinement Over Revolution: Instead of overhauling the entire SFDR, the focus should be on reviewing it. The core components of Article 8 and 9 funds should remain, but with well-defined conditions and criteria that need to be met. The main difficulty will be defining these criteria; for now, discussions focus on Taxonomy alignment, engagement strategies or exclusions.
- Beyond Taxonomy: While no clear consensus has emerged regarding the choice of these criteria, Taxonomy alignment, as it stands, cannot be the only one used to assess the sustainability of funds. Indeed, all stakeholders agree that focusing primarily on the Green Taxonomy would lead to the exclusion of funds with a social objective, and the current Taxonomy is not suitable for diversified portfolios with investments in a variety of sectors and activities.
- Tailored Disclosures: Given the diverse audience of sustainability disclosures and their level of literacy, there’s a suggestion to differentiate the disclosures for retail and institutional investors. This could involve simplifying information for retail investors with the aid of labels or fund categorization.
Conclusion & What’s Next
The European Commission is set to finalize the consultation process and the technical workshops in the upcoming months, at the latest in the beginning of next year. It will subsequently release a report consolidating its findings.
The final decision regarding whether SFDR will be reviewed, to which extent and when will be in the hands of the next European Commission to be elected in 2024. In other words, there are probably no changes to be expected before September 2024. Stay tuned.
