SFDR should switch to labelling system to enhance transparency and counter greenwashing risk

22 November 2023 (IEEFA) | 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.

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,” said Alasdair Docherty, author of the report and a sustainable finance and data analyst at IEEFA. “This far-reaching consultation shows that standard setters have been listening and presents an opportunity to rework an unfair and confusing article categorisation system.”

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.”

Read the report: https://ieefa.org/resources/sfdrs-early-life-crisis-presents-opportunity-level-playing-field

Notes to editors:

• The European Commission’s SFDR consultation closes on 15 December 2023. Any proposed changes from the process would not come into effect for several years.

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The Institute for Energy Economics and Financial Analysis (IEEFA) examines issues related to energy markets, trends and policies. The Institute’s mission is to accelerate the transition to a diverse, sustainable and profitable energy economy. www.ieefa.org