SFDR heading for the scrap heap? European Commission launches SFDR consultation
15 September 2023
15 September 2023
The consultation:
Here the European Commission asks for feedback on whether the SFDR's objectives are still relevant and whether it has achieved those objectives (increasing transparency of sustainability risks, increasing transparency towards end investors in relation to consideration of adverse sustainability impacts, strengthening protection for end investors, channelling capital towards sustainable investments, including transitional investments(?!). There are some additional questions on whether the costs of the regime are proportionate to the benefits (and we would eat our hats if the consensus on this comes out positive) and the effects of SFDR.
Question 1.7 is interesting as it clearly sets out some of the key criticisms of the regime and asks whether respondents agree that (amongst others):
This section also seeks input on the effectiveness of principal adverse impacts and (a) whether PAIS create methodological challenges and (b) whether it is clear how PAIS should be used in do no significant harm assessments. This section looks at the costs incurred by firms and requests significant breakdown of costs incurred. Finally the section seeks input on data challenges and the use of estimates under SFDR.
In this section the European Commission seeks feedback on whether some of the recent Q&A publications have provided sufficient clarity on certain issues, such as the classification of funds using PABs or CTBs or the interoperability of SFDR and CSRD, MiFID, IDD and PRIIPS KID.
This section asks some existential questions about the SFDR, including whether the SFDR is the right place to include entity level disclosures and how sustainability information could be streamlined across different pieces of legislation.
It also looks at product level disclosures. Here the consultation acknowledges that '[t]he SFDR was designed as a disclosure regime but is being used as a labelling scheme, suggesting that there might be demand for establishing sustainability product categories'. The European Commission is quick to highlight that the questions analysing the need for possible changes to disclosures, as well as potential link between product categories and disclosures, 'does not pre-empt in any way a decision about how a potential categorisation system and an updated disclosure regime' would interact if these were established'.
The European Commission suggests it could also consider expanding the sustainability information to be provided by article 6 products. It says, 'providing proportionate information on the sustainability profile of a product which does not make sustainability claims could make it easier for some investors to understand products' sustainability performance as they would get information also about products that are not designed to achieve any sustainability related outcome'. Here they ask: Would uniform disclosure requirements for some financial products be a more appropriate approach, regardless of their sustainability-related claims (e.g. products whose assets under management, or equivalent, would exceed a certain threshold to be defined, products intended solely for retail investors…)? Disclosures suggested include taxonomy related disclosures, engagement strategies, exclusions, or information about how ESG related information is used in the investment process.
This section also questions whether current disclosures are made in the right place (i.e. precontractual documents, periodic reports and websites). Should scales be used to reflect different financial products? Should disclosures be standardised and digitised for better machine readability?
Finally the questionnaire considers whether a classification system for financial products ought to be established. This is where the European Commission acknowledges that 'Articles 8 and 9 of the SFDR are being used as de facto product labels together with the proliferation of national ESG/sustainability labels, suggests that there is a market demand for such tools in order to communicate the ESG / sustainability performance of financial products. 'There are persistent concerns that the current market use of the SFDR as a labelling regime might lead to risks of greenwashing', the European Commission acknowledges. The questions in this section presume that any such classification regime would be voluntary.
If the Commission was to propose the development of a product categorisation system, it envisages two potential strategies:
The Commission also gives an early indication of the types of categories it could adopt which includes:
The European Commission also queries whether there is merit to distinguishing between products with a social focus and an environmental focus. There is a significant number of questions around how a new categorisation system could and should work, including the transition to such a regime and whether rules on naming and marketing communications would also be needed.
While the European Commission is at pains to emphasise that the questions do not reflect their preferred policy approach the number and depth of the questions reflect a pressing need for significant overhaul of the SFDR framework. While the European Commission doesn't put it in so many words, it looks as if they have at last accepted that the current regime is unworkable.
While responding to the questionnaire will be a significant task in itself it is important for all firms to shape the reforms that are likely to come out of this process. The alternative would be that we are looking at tinkering around the edges of SFDR which no one wants.
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