Addressing investor concerns, the European Commission is proposing a significant overhaul of the bloc’s ESG fund framework, aiming to enhance manageability and mitigate greenwashing risk.
The EU’s executive arm is targeting a dramatic rewrite of the Sustainable Finance Disclosure Regulation, according to a commission document seen by Bloomberg. The goal is to have three distinct categories of environmental, social and governance-linked investment products; to require funds to disclose fewer ESG data points than they do today; and to do away with some firm-wide requirements.
The decision reflects the changing mood toward ESG rules across Europe, where governments have warned that the existing regulatory framework is hampering the bloc’s competitiveness. ESG requirements for companies are already on the chopping block, with only a tiny fraction of those originally intended to be in scope now likely to be required to comply.
SFDR has faced criticism from investors — and even some national regulators — for requiring data points that aren’t available, and for insisting on disclosure and sustainability concepts that are prone to misinterpretation. Meanwhile, SFDR fund categories have opened the door to greenwashing, according to academic studies.
ESG products under SFDR’s existing disclosure categories (known as Articles 8 and 9) account for almost half the EU’s assets under management, and more than 60% of funds in the bloc, according to the commission. Article 6 — which only requires managers to screen for ESG risks — makes up the rest.
The commission said there’s evidence that fund disclosures to investors under Articles 8 and 9 have “been used by the market in a misleading way to categorize financial products as sustainable despite the lack of criteria that could fit this purpose.”
In its review of SFDR, the European Commission said that “evidence shows the objective of investor protection has not been sufficiently well served.” The new categorizations would “give investors a clear choice,” according to the proposal.
Instead of disclosure categories, the commission is recommending that sustainability-related financial products “should be distinguished in terms of whether their main objective is to pursue an environmental or social sustainability objective, to support an environmental or social transition-related objective, or to integrate other sustainability considerations as part of their strategy.”
The commission is also calling for funds that claim to be sustainability-related to invest at least 70% in assets that are related to an ESG strategy. General-purpose sovereign bonds can’t be included because there’s currently no way to measure a country’s sustainability profile, it said.
While the changes will mean some upfront expenses, the commission estimates that financial firms subject to SFDR stand to save at least 25% of the current cost of compliance, over the long term.
Financial Services Commissioner Maria Luis Albuquerque said in a Nov. 5 speech that the goal is to introduce a “clearer, simpler” product classification this month. A spokesperson for the commission declined to comment.
Sebastien Godinot, senior economist at WWF European Policy Office, said the commission’s proposed changes to SFDR don’t do enough to ensure that ESG portfolio managers will be required to exclude unsustainable companies and select firms that are sustainable.
The proposal also “provides no guarantee of gradual alignment with the Paris Agreement’s objectives,” he said in a written comment. “The level of ambition in the text is worse than existing market practice on several counts.”
