The ESMA has recently recommended a significant overhaul of the Sustainable Finance Disclosure Regulation (SFDR) within the EU.
According to Environmental Finance, this recommendation comes as part of an ongoing effort to simplify and improve the clarity of sustainable investment regulations, aiming to curb the prevalent issue of greenwashing in the sector.
ESMA has proposed the abolition of the current definition of ‘sustainable investment’ under the SFDR and suggested a new two-tier system. This system would include a voluntary category aligned with the EU taxonomy for sustainable activities and a ‘transition’ category. The transition category would be assessed through key performance indicators that gauge the progress of reducing sustainability impacts over time and apply a less stringent ‘do no significant harm’ (DNSH) criteria.
According to Hortense Bioy, the head of sustainable investing research at Morningstar Sustainalytics, this new system would effectively render the current SFDR Articles 8 and 9 redundant, potentially reshaping the EU market for sustainable investment funds. These changes aim to enhance market consolidation and gradually eliminate national labels, which are common in countries like France, Germany, and the Nordics.
The reform suggestions include requiring all financial products to disclose sustainability information in line with an expanded EU taxonomy. This taxonomy would now include social and transitional activities, enhancing comparability across different financial products and reducing the scope for misleading information.
ESMA also advocates for the European Commission to establish a clear legal definition for ‘transition’ investments, which would facilitate more reliable assessments of transition plan disclosures. Additionally, the creation of ‘transition benchmarks’, tougher EU climate benchmarks, and standards for transition bonds and sustainability-linked bonds have been proposed.
On the data front, ESMA has called for the regulation of ESG data products, akin to the EU ESG Ratings regulation, to tackle issues related to data quality, consistency, and reliance on estimates.
These recommendations come at a time when the EU Commission is reviewing potential improvements to the SFDR, following extensive criticism regarding its complexity. Recent data from Morningstar highlighted that Article 9 funds, which target the highest level of sustainability ambition, have seen over €4 billion in withdrawals in the second quarter of this year. In contrast, Article 8 funds, aiming for a lower sustainability level, attracted about €26 billion, though this still falls short compared to the inflows seen by Article 6 funds, which lack a sustainability focus.
Bioy also noted a trend in the reclassification of funds between different SFDR Articles, with several funds removing ESG terms from their names. This trend is expected to continue, with more fund rebranding anticipated in the coming months.
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