The European Commission (“EC”) is expected to publish a proposal for the revision of the SFDR in 2025. In preparation, both a public and a targeted consultation on "SFDR 2.0" were held between September 14 and December 22, 2023. In the targeted consultation, the EC noted that financial market participants (“FMPs”) are applying the SFDR differently than originally intended. Instead of using the product classifications to determine what information must be disclosed and how it should be reported, FMPs are using the SFDR to effectively ‘market’ their financial products. They see the SFDR product classifications not just as a transparency framework, but as a sustainability label or certification. In this context, Article 8 SFDR is perceived as ‘somewhat sustainable,’ while Article 9 SFDR is considered ‘highly sustainable.’ In the market, these products are often referred to as ‘light green’ and ‘dark green’ products.
The EC is expected to base its proposal largely on the Report from the European Platform on Sustainable Finance (“the Platform”), which provides advisory guidance on the design of a potential categorisation system under the SFDR. The Report aligns closely with previously published opinions from the ESAs and ESMA. While non-binding and indicative in nature, the Report is anticipated to significantly influence the EC’s decision-making process for SFDR 2.0.
The Platform recommends that each category include minimum criteria, such as a defined percentage of investments contributing to sustainability objective(s). The proposed categorisation system aims to align sustainability characteristics and strategies with the expectations of retail investors.
Where feasible, existing indicators from the current Sustainable Finance Framework should be utilized, subject to sufficient data availability. FMPs are required to identify binding elements for their products and select indicators to monitor and measure progress towards the set sustainability goals.
The Platform suggests categorizing products into three distinct groups based on their sustainability strategies:
This category encompasses taxonomy-aligned or sustainable investments, as defined in Article 2(17) SFDR. The Platform further recommends implementing a mandatory exclusion list based on the EU Paris-Aligned Benchmarks (“PAB”), with certain adjustments. The remaining portion non-sustainable investments must meet the "Do No Significant Harm" (“DNSH”)-test based on relevant PAIs. DNSH-thresholds must be supported by scientific evidence.
The Platform suggests refining the definition of sustainable investments and the DNSH-test to better align with the Taxonomy framework. It also recommends adding a definition of impact investments to enhance transparency and clarity. The Platform advises strengthening the definition of sustainable investments and the DNSH-test and better aligning them with the existing Taxonomy framework. Unlike the Taxonomy Regulation, which uses clear screening criteria and measurable standards, the SFDR definition of 'sustainable investment' leaves room for interpretation. The Taxonomy requires a substantial contribution to an environmental objective, while Article 2(17) SFDR acknowledges any contribution defined as substantial by FMPs toward a sustainable objective. The Platform advises that FMPs should only self-define a substantial contribution to environmental objectives and the DNSH-test to economic activities not covered by the Taxonomy Regulation. As the EU Taxonomy develops further, the need for self-defined "sustainable investments" will decrease.
While the term "impact" is commonly used in marketing for Article 9 SFDR products, the Report does not introduce a specific "Impact"-category. As the SFDR lacks a definition of impact investments, the Platform deems it important to provide such a definition to enhance transparency and clarity. The Platform recommends that the EC establish a shared understanding of impact investing, aligned with the Taxonomy Regulation, and incorporate this understanding into the categorisation framework.
Financing the transition to a climate-neutral and sustainable economy is the cornerstone of the EU Sustainable Finance Agenda. "Transition investing" is a new concept within the Sustainable Finance Framework. Investments aimed at the transition to a more sustainable world, such as CO₂-reduction, can be implemented at the project, investment, and portfolio levels. In this context, the Platform has also published a report on Transition Benchmarks and Climate Transition Plans.
This category requires that a minimum percentage of investments be transition related. Investments eligible for this category include, among others:
Investments that meet the DNSH thresholds but have not yet made a substantial contribution may still qualify, including those engaged in harmful activities, provided a credible transition plan is in place. This plan should aim to gradually convert these investments into more sustainable alternatives over time.
Physical assets, such as real estate and infrastructure, require significant capital to fund sustainability improvements. The Platform gives an example of a binding element in this category, namely acquiring real estate with the goal of renovating it to achieve an A energy efficiency rating.
The Platform advises aligning with the Climate Transition Benchmark (“CTB”) exclusions, adjusting them for transition portfolios. Unlike the PAB-exclusions, the CTB-exclusions permits investments in fossil fuels, as transition strategies may include such investments. However, the Platform stresses that activities that are, or remain, non-transformable must always be excluded.
A product with a CO₂ reduction goal must track its progress against a CTB. The Platform recommends integrating additional factors, such as biodiversity and social considerations (e.g., "Just Transition"), alongside climate criteria. These should be measured with enhanced methods and more accessible data. An optional binding element is a stewardship strategy, including engagement and voting policies to encourage companies that are not yet fully transitioning.
The ESG-Collection category includes products with sustainability characteristics that do not fall under the Sustainable or Transition categories. These products may involve negative screening (excluding poorly performing investments) or positive screening (selecting the best-performing investments). It also includes products focused on improving sustainability performance through annual progress, as well as those that blend Sustainable and Transition investments, such as through a mixed portfolio. Products can only be assigned to one category, in contrast to the UK's mixed-label approach under the SDR.
Reporting on PAI indicators is mandatory to assess sustainability performance and ensure that other investments do not undermine the product's ESG objectives. Environmental PAIs must be reported for environmental-focused products, and relevant PAIs should be used when both environmental and social aspects are involved. As with the Transition category, the adjusted CTB-exclusions apply. The Platform highlights that this category may be challenging to explain to end investors due to its diversity. Clear naming, descriptions, and pre-contractual information are essential to communicate the breadth of products included.
Unclassified products include all products that do not fall within the three previously described categories. These products may:
Products in this category have minimal reporting obligations. However, they must explain how they assess sustainability risks (similar to the current Article 6 SFDR). The Platform advises mandatory reporting on taxonomy alignment, greenhouse gas emissions, and human rights due diligence. The following sustainability indicators must be reported:
ESG-, sustainable-, or transition-characteristics may only be proportionally mentioned in legal documentation, without misleading marketing. The disclaimer must clearly state that:
Category names and sustainability-related terms may only be used by products that meet the proposed categories. Categorisation must also align with the Green Claims Directive and the Directive to Empower Consumers for the Green Transition. FMPs must be able to demonstrate that a product genuinely meets the requirements of the assigned category.
Products focusing on social aspects can generally fit within any category. Although the sustainable finance framework pays attention to human rights and governance, specific social objectives and indicators are not yet fully defined. Further efforts are needed to clearly establish these, focusing on PAIs and the social standards of the ESRS.
The Report primarily focuses on retail products, but institutional products, including non-EU funds offered in the EU, also fall under the proposed categorisation system.
Sustainability preferences reflect an investor’s desired integration of sustainability factors into their investments. These preferences may vary based on the investor’s values and the extent to which they wish to prioritize environmental, social, and governance aspects in their portfolio.
The current inquiry into sustainability preferences poses challenges for advisors and investors. Minimum percentages for indicators may not be ideal for determining client preferences and matching them with suitable products. The legislation links sustainability preferences to the requirement for minimum allocations in sustainable investments, in accordance with the Taxonomy and Article 2(17) of the SFDR, and the consideration of PAIs. Furthermore, the dual definition of "sustainable investment" within the existing sustainable finance framework remains unclear and ambiguous to consumers.
The Platform advocates for a revision of sustainability preferences, moving away from the use of specific indicators and minimum percentages. The inquiry should include different layers, allowing the investor to delve deeper into aspects they find important. For retail investors without a pronounced focus on sustainability, all categorized products can be offered, as long as they meet their general investment and financial objectives.
The Platform remarks that a preference for considering PAIs may indicate a desire to avoid harmful investments, while an interest in Taxonomy alignment or sustainable investments suggests that the investor seeks to invest in products already deemed sustainable.
FMPs have already invested significant time and resources in understanding, operationalising, and building reporting systems according to existing SFDR principles. Therefore, it must be clear how products currently falling under Articles 6, 8, and 9 of the SFDR fit into the proposed categories. The Platform believes that products can be assigned to the proposed categories as follows:
The Platform points out that some Article 8 or 9 SFDR products may not meet the new criteria. The proposed obligation to prohibit unclassified products from referencing ESG characteristics in marketing materials could result in many existing Article 8 products adjusting their ESG features or ceasing to promote them altogether.
The Platform consciously avoids using the term 'label,' as it pertains to evaluating individual products, while categorisation organises products into distinct groups based on common characteristics. The Platform believes that a well-structured categorisation system offers sufficient clarity, making mandatory assurance unnecessary. However, it still allows for the option of FMPs voluntarily seeking external assurance.
The Platform stresses the need for thorough testing of the proposed approach to ensure it meets the needs of retail investors and FMPs. This includes assessing ESG data availability, impact on current product offerings, and refining minimum criteria. Consideration must also be given to retail investors’ knowledge, sustainability preferences, and the implications for FMPs' asset allocation. A balanced approach will be essential to ensure both effectiveness and practicality.
The proposed changes present both opportunities and challenges. While FMPs will need to adapt to stricter criteria and reporting obligations, including the requirement to report PAI indicators for all SFDR-covered products, this revision offers a chance to better align investor preferences with sustainable products. It can also encourage transition investments, enhancing sustainability across all sectors.
While the report mainly addresses retail funds, institutional investment funds, including non-EU funds offered in the EU, may also be impacted if the EC adopts the proposed categorisation. SFDR 2.0 could further streamline sustainable finance and elevate responsible investing, fostering greater alignment between investor preferences and sustainable investment practices.
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