The most notable changes include the introduction of three investment product categories, Sustainable, Transition and ESG Basics, which replace the current Article 6, 8 and 9 fund classifications. Other key changes are the introduction of exclusions-based requirements for these categories and the removal of entity-level Principal Adverse Impact (PAI) reporting. At first glance, we welcome these changes. Particularly the introduction of exclusions-based requirements, as these function as a scientific definition of harm. And also the removal of entity-level reporting, as this will save a lot of administrative burden at the cost of sustainability data that are of little use. However, the devil is in the details.
Lack of a level playing field
A key missed opportunity in the proposal is the lack of a level playing field between categorised and non-categorised investment products. Only categorised funds are required to disclose information, with transparency requirements increasing from ESG Basics to Transition, and then to Sustainable. For non-categorised funds, disclosure remains voluntary. The rationale for demanding transparency from sustainable funds is that it enables end-users to understand potential harm. However, this logic should extend to all investment products, especially non-categorised ones, where most harm may occur. At present, the proposal effectively requires disclaimers for sustainable products, while potentially harmful products can avoid disclosure. Non-categorised products should be required to report on the harm they do.
No improved clarity and comparability for retail investors
To qualify for the categories ESG Basics, Transition and Sustainable, 70% of the portfolio needs to be made in accordance with the sustainability-related claim, i.e. the objective that is pursued or the sustainability-related considerations that are applied. While the introduction of a threshold is welcome, we are concerned that the proposal does not sufficiently improve clarity and comparability for retail investors.
The requirements are highly flexible and can vary significantly between funds. ESG Basics, in particular, is susceptible to greenwashing, with free interpretation of everything: a minimum proportion of aligned assets, no ex-ante sustainability-aimed outcome and no clear specifics on how to assess ESG integration. Additionally, the Transition category appears to focus on the green transition, neglecting the equally important social transition due to the complexity of developing and setting measurable indicators. It is also worth noting that the ESMA guidelines for fund names require an 80% threshold. Although the criteria differ, applying different thresholds for fund names and fund categories may cause confusion.
Weak criteria and loopholes
We welcome the introduction and alignment of exclusions to other EU legislation. However, for ESG Basics the criteria remain weak. Activities financed may still include new and ongoing fossil fuel practices (excluding coal and lignite). This could result in investors inadvertently financing an oil company’s drilling platform without it having a transition plan, under the impression that this investment is considered ESG-compliant.
In summary, the proposal is an improvement over the current SFDR. Nevertheless, it fails to address the lack of a level-playing field and there are some loopholes that need to be closed in order to combat greenwashing. Otherwise investors risk being misled and sustainable finance will fall short of its true potential.
