EU Commission Consultations on SFDR
On September 14, 2023, the European Commission launched two consultations on the implementation of the Sustainable Finance Disclosures Regulation ("SFDR"): One targeted at public bodies and expert stakeholders, and one aimed at a broader range of public stakeholders. The consultations focus on potential shortcomings of the SFDR, including legal certainty, the usability of the regulation, and its ability to stop greenwashing.
In particular, the expert-targeted consultation covers:
- Current requirements of the SFDR;
- Interaction with other sustainable finance legislation;
- Potential changes to the disclosure requirements for financial market participants; and
- Potential establishment of a categorization system for financial products.
The public consultation just covers (1) and (2).
Sections 1 and 2 cover the SFDR as it is today, exploring how the regulation is working in practice and the potential issues stakeholders might be facing in implementation. The consultation raises many important questions, which may strike a chord with some investment managers, including whether:
- The SFDR disclosures are useful for investors;
- The requirements and concepts in the SFDR are sufficiently clear;
- Data gaps make it challenging to disclose in full compliance;
- Issues arising create legal uncertainty and reputational risks for the financial market; and
- There is room to streamline the entity level disclosure requirements of the SFDR and the Corporate Sustainability Reporting Directive.
Many investment managers have experienced challenges on SFDR reporting, often due to the difficulty of obtaining reliable ESG-related data and uncertainty as to how best to meet the legal requirements of the SFDR.
Sections 3 and 4 look to the future, assessing possible options to address any potential shortcomings. The consultation notes that the general principle of the SFDR is that products that make sustainability claims, including with respect to climate change, need to disclose information to back up those claims to avoid the risk of greenwashing. However, this could be viewed as placing additional burden on products that factor in sustainability considerations. As such, the Commission queries whether there should be uniform standardized disclosure requirements for products across the board, regardless of their sustainability-related claims.
Of particular interest is the Commission's acknowledgment that, although the SFDR was designed as a disclosure regime, it is being used as a de facto labelling scheme, suggesting that there is a market demand for establishing categories for sustainable financial products. The Commission is therefore seeking views on the merits of developing a more precise EU-level product categorization system, and it has suggested two potential pathways for developing such a system. The first option suggests that the product categorization system could build on and develop the distinction between Articles 8 and 9 and the existing concepts embedded in them (such as environmental/social characteristics, sustainable investment, or "do no significant harm"). The second option suggests the product categorization system could be based on a different approach that does not relate to the existing concepts; for instance, an approach focused on the type of investment strategy (such as the promise of positive contributions to certain sustainability objectives, transition focus, etc.).
The introduction of a product categorization system would be a significant change for the EU investment management market, and a key concern for investment managers will be ensuring that any new categorization system will work alongside the disclosure requirements and labelling regimes of other key jurisdictions. On this point, we note that the UK's Financial Conduct Authority is expected to publish its Sustainability Disclosure Requirements and investment labels policy statement later this year.
The expert-targeted consultation has already generated a lot of market interest and suggests that there could be material amendments to the SFDR in due course—although it is likely that any substantial changes to the SFDR would take time before coming into effect.
The consultations run until December 15, 2023, and the Commission aims to publish a finalized report in Q2 2024.