09 Mar SFDR definitions will deliver clarity and transparency for sustainable investment
The Sustainable Finance Disclosure Regulation (SFDR) was introduced to bring accountability and discipline toward sustainability claims concerning financial products and to enhance the quality and connection of details related to their performance associated with sustainability.
SFDR requires managers to measure and disclose how sustainability risks are managed within investment plans and how they consider investment decisions that may detrimentally impact sustainability factors, referred to as Principal Adverse Impacts (PAIs).
In the last month, French Regulator (Autorité des Marchés Financiers (“AMF”) proposed to the European Commission a list of recommended changes to the SFDR as part of its review of the regulation. Proposals include implementing minimum environmental requirements that must be met by financial products to enable classification within Article 8 or Article 9 in the SFDR.
The AMF stated that SFDR and the associated Article 8 and 9 classifications do not enable investors to appropriately assess or compare the level of sustainability of investment strategies made by financial products. The AMF highlighted that SFDR lacks minimum requirements for products compliant with Article 8 or 9, requiring financial market participants to share details about claims and practices on sustainability matters. The AMF has proposed the following changes:
Introduce minimum standards for articles 8 and 9 financial products. The AMF suggests the EC maintain the articles categories but that it includes additional minimum standards that products must meet.
-Elaborate on the definition of sustainable investments. The AMF believes the definition of ‘sustainable investment’ within the SFDR is too vague and should replace with a new definition incorporating requirements to make it more concrete.
-FMPs managing Article 8 or Article 9 financial products should adopt pre-determined ‘acceptable’ ESG approaches within the investment decision-making plans. The AMF suggests producing an EU framework for minimum standards that would determine a series of acceptable ESG measures that an FMP may introduce for its financial products to be classified as Article 8 or Article 9.
-AMF also propose that article 9 financial products should exclude investments in fossil fuel activities that don’t align with the EU Taxonomy Regulation. Investment in these activities would be possible for article 8 financial products, provided they meet strict conditions.
The AMF explains that the proposals intend to trigger discussions on the minimum requirements given the EC review of SFDR. If followed, the proposals would likely have a considerable impact on the asset management market and potentially cause many FMPs to reassess the classification of their funds under SFDR and possibly revise their approach toward ESG products.
The regulatory landscape is transforming, especially in the last year, with EU regulation focusing on possible greenwashing, leading to a reclassification of sustainable funds. Within the EU SFDR, all EU investments fit within one of three categories: Article 8 or ‘light green’ products promoting environmental or social factors; Article 9 ‘dark green’ products, which have a dominant sustainability objective and Article 6, which have no sustainability objective at all.
At the beginning of the year, SFDR 2 came into play, requiring more detailed reporting from fund managers, especially for Article 9 funds that only consist of 100% sustainable investments. According to the quarterly analysis of European SFDR investments from research business Morningstar, a record number of funds were downgraded from Article 9 to Article 8 near the end of 2022 in preparation for stricter disclosure requirements.
The downgrades suggest that the number of funds classed as Article 9 has reduced to its lowest level yet of total SFDR funds. Morningstar believes this is associated with regulation, including the standards expected, requiring funds that include ‘impact’ in their names to determine how they make investments with the plan to generate positive and measurable environmental and social impacts, as well as a financial return.
Asset managers focused on managing funds that follow a decisive impact investment strategy are becoming leaders within the sustainability scene. The availability of sustainability-focused investments may have declined, but it has also become clear which investments are sustainable.
The UK is currently developing its own SFDR called SDR, which will include a dedicated ‘sustainable-impact’ category. There are, however, complications within the proposal that require attention. The Impact Investing Institute warned that parts of the SDR definition of ‘impact’ do not align with or support the path of the global impact investment market.
As with the case of SFDR, the introduction of new and specific definitions around determining a sustainable fund is creating some issues in the short term, causing some investors to reassess their plans to detail funds as having sustainable objectives. In the long term, however, added scrutiny will create more clarity and transparency for sustainable investment.