EU sustainability disclosure “earthquake” leaked
Leaked draft of European Commission’s Sustainable Finance Disclosure Regulation (SFDR) revamp shows reform of many of its most controversial features.
The leak, first reported by Responsible Investor on November 6th, came weeks before the Commission is set to formally review the regulation on November 19th.
SFDR has applied to sustainable funds managed out of the European Union since 2021. Originally intended to combat greenwashing among investment managers, many in the industry have complained that complying is confusing, expensive work.
The problem is that investors have had a hard time understanding what a “sustainable investment” actually is.
Goodbye, PAIs?
One of the most bemoaned requirements of the current regulation is entity-level reporting on 14 mandatory Principal Adverse Impact indicators (PAIs), which entail a hefty administrative toll on investment teams. The leak suggests this requirement might be abandoned.
However, PAI critics shouldn’t get too excited. Luciano Asinelli, ESG Regulation Analyst at Impact Cubed, told Felix that “PAI indicators themselves are expected to remain as the quantitative backbone of SFDR 2.0.” Just how they will live on in the new regime will be of particular interest to investors.
More labels, less confusion?
The reported reshuffle of existing sustainable fund categories has also caused a stir. Investors currently rely on the Commission’s definition of “sustainable investments” for fund classification – “dark green” Article 9 funds must ensure that 100% of holdings meet this criteria.
The problem is that investors have had a hard time understanding what a “sustainable investment” actually is. Seemingly attempting to respond to this confusion, the Commission is said to be scrapping this definition and instead mandating that 70% of holdings in sustainable funds meet more clearly articulated guidelines. A new “transition” category is also set to be announced, where investors must demonstrate that holdings “meet a clear and measurable transition objective.”
Asinelli says that this marks “a shift from qualitative to quantitative justification” at the heart of the regulation, and that it “limits the potential for overstated environmental or social claims.” He states: “The clearer categories should reduce compliance costs while improving cross-market consistency, narrowing the gap between regulatory ambition and operational feasibility.”
What’s next?
Whilst the Commission has not commented on the leak, investors will be keen to find out if these changes will go ahead. Law firm Simmons & Simmons professed that the leaked draft represents an “earthquake” for Europe’s ESG regulation space. Many would certainly welcome the lowered administrative burden entailed by the overhaul, though questions remain about the precise details of the reforms.
Time will tell – Asinelli says investors should anticipate “a phased implementation rather than an abrupt switch.” In the meantime, he says “the prudent move for asset managers now is to start mapping their current Article 8 and 9 products to the proposed categories, identifying data gaps, and preparing to substantiate sustainability claims through transparency, indicatorlevel evidence once the final rules are in place.”
