Greenwashing refers to the provision of inaccurate or misleading sustainability-related statements, declarations or actions, or the omission of essential sustainability information in business operations. The Sustainable Finance Disclosure Regulation (SFDR) requires financial market participants and financial advisers to provide comparable information on how they consider Principal Adverse Impacts (PAI indicators) in their operations. Companies must also disclose details on the ESG strategies of their financial products and how they incorporate sustainability risks in investment activities or advisory services.
Regulations leave room for interpretation
SFDR came into effect in 2021, but its second stage of regulation, including the Commission Delegated Regulation, was issued in 2022 and mostly came into force in early 2023. Along with third-level regulations and Commission guidelines, these new rules redefined many aspects of the disclosure requirements.
There is still significant room for interpretation, leading to diverging applications and varied industry practices. Additionally, in February 2023, the Commission amended the original SFDR Delegated Regulation, introducing technical modifications, particularly regarding financial products’ exposure to fossil gas and nuclear energy investment risks.
Sustainability data lacks specificity
Although many FSAs have yet to conduct a thematic review on sustainability risks in investment funds, Finland’s Financial Supervisory Authority (FSA) has taken the initiative. In 2024, it published a two-part thematic review on the consideration of sustainability risks in investment funds and their sustainability disclosures. The first part, released on March 20, 2024, focused on preventing greenwashing, while the second part, published on November 15, 2024, addressed sustainability disclosures and the role of risk management in monitoring sustainability risks. The authority found shortcomings in nearly all assessed areas, noting that sustainability disclosures were often too general and lacked concrete information.
The European Commission revises disclosure regulations
Maria Luis Albuquerque, European Commissioner for Financial Services, stated in November 2024 before the ECON committee that the SFDR framework is being misused, as a pseudo-labelling regime, and this does create greenwashing risks. Albuquerque’s vision includes not only a clear designation for green investments but also a separate label for transition investments. As she pointed out, “That’s actually where the majority of our productive sector is.”
In September 2023, the European Commission launched a targeted consultation to gather industry feedback on on the implementation and potential reform of the SFDR. The consultation aimed to assess legal certainty, usability, and effectiveness in addressing greenwashing concerns. The consultation focused on several key themes:
1. Current requirements of the SFDR: This section aimed to gather insights into how well SFDR functions in practice and what potential issues exist. The questions focused on the relevance and usability of Principal Adverse Impact (PAI) disclosures, the cost-benefit assessment of regulations, and challenges related to data gaps. Additionally, the section sought to understand whether companies have expanded their offerings of sustainability-focused financial products since SFDR’s implementation, and if so, what factors have influenced this development.
2. Interaction with other Sustainable Finance Regulations: This section's questions focus was on the alignment, and inconsistencies between SFDR and other regulations. These regulations include the Taxonomy Regulation (e.g., the definition of sustainable investments/sustainable activities and Do No Significant Harm (DNSH) tests), the Benchmark Regulation, MiFID II (e.g., sustainability preferences), CSRD, IDD, and PRIIPS (e.g., disclosures related to the Commission’s retail investment strategy). Many respondents support aligning SFDR pre-contractual disclosures with the PRIIPs KID and investors' sustainability preferences. The questions also seek insights into the Commission’s latest Q&A clarifications, such as the definition of sustainable investment and the status of index-linked products.
3. Potential Changes to Disclosure Requirements: Entity level disclosures: The questions explore whether these disclosures are generally useful, which Principal Adverse Impact (PAI) indicators are most beneficial, whether SFDR is the appropriate framework for entity-level disclosures, and whether it would be possible to harmonize entity-level reporting across different regulations.
Product level disclosures: Interestingly, the consultation sought views on potential changes to the product level disclosures, specifically on whether the framework should impose uniform requirements for all or for some financial products regardless of their sustainability-related claims (i.e., including Article 6 funds), and whether additional disclosure requirements should be required from financial products that make sustainability-related claims.
4. Potential Establishment of a categorisation system for financial products: Notably, the European Commission is examining whether to introduce new product categories based on sustainability objectives and well-defined criteria. The questions address the potential benefits and effectiveness of this approach and how these categories should be structured.
The Platform on Sustainable Finance, an advisory body to the European Commission, has published a briefing note for the Commission in December 2024 outlining how a categorisation system for sustainable finance products could be set up and calibrated. While the platform’s proposal is not binding, it is expected to have a significant influence if the Commission decides to amend SFDR. The advisory group has stated that its proposal builds on the existing regulatory framework so that any changes will not undermine prior developments. The Platform recommends categorising products based on their strategic approach into three groups:
- Sustainable financial products
- Transition products
- ESG collection products
All other products should be identified as unclassified products. The most substantial shift appears to be the move away from a reporting-based system toward a classification-based system, where even ESG collection products, which closely resemble Article 8 funds, would be subject to binding criteria.
According to the Commission's plans, the draft proposal to amend SFDR is expected to be published in the last quarter of this year.
Before this, the Platform on Sustainable Finance may release additional recommendations. Due to the regulatory level of SFDR, its final approval requires negotiations through the so-called trilogue, involving discussions between the European Commission, Parliament, and Council.
The way financial market participants and investment advisors promote and describe their products has raised concerns among the Commission and regulatory authorities. Since sustainable investing is evolving, and the terminology is not yet fully standardized, transparent and responsible disclosures are essential to help investors accurately understand the sustainability characteristics and risks associated with financial products.
