In March 2021 the Sustainable Finance Disclosure Regulation (”SFDR” EU 2019/2088) entered into force. The objective of the regulation is to direct more funds to sustainable investments by enforcing investors’ trust towards these kinds of investments by preventing green washing with added transparency, i.e. disclosure obligations. In order to meet its objective, among other obligations SFDR requires fund managers as well as other financial market participants to classify their financial products. Although, SFDR is not only a ‘classification regulation’, classification is important for the fund managers because it determines the specific disclosure obligations for the product in question. Something to consider is that even a product’s name could slip the investment into another category, thereby invoking its disclosure obligations for the said financial product.
Under SFDR, financial products are separated into three different categories. On one end of the spectrum, there are financial products that do not have any sustainability drivers (“Article 6 funds”) and on the other end, there are funds that have sustainable investment as their objective (“Article 9 funds”). In between, there is a category of products that promote among other things environmental or social characters or a combination of these and comply with good corporate governance practices. These Article 8 products have become popular in the market. In this blog post we analyze what exactly constitutes ‘promotion’ of E or S and how Article 8 funds differ from the other financial product categories.
Definition of “Promotion” is twofold
According to the EU Commission, “Article 8 means that where a financial product complies with certain environmental, social or sustainability requirements or restrictions laid down by law, including international conventions, or voluntary codes, and these characteristics are “promoted” in the investment policy the financial product is subject to Article 8 disclosure obligations.”1 Furthermore, according to the EU Commission, promotion means any direct or indirect claims, information, reporting and disclosures related to the fact that environmental or social characters are considered.
Thereby, characteristics refer to any pre-defined environmental or social factors. The definition of promotion of these characters, however, seems to be twofold. On one hand, promotion covers different languages used in marketing and disclosures from simply the name of the product up to making ESG statements in the products’ policies and strategy. This first requirement limits the possibilities of green washing and separates Article 8 products from Article 6. For example, if the product is described as sustainable or responsible in any product materials or the name of the product, Article 6 disclosures are no longer sufficient, but the product should follow Article 8 disclosure requirements instead.
On the other hand, the second requirement of promotion indicates actively driving ESG factors in the product’s investment policy and strategy. The second requirement should not be seen as a limitation but as an opportunity. Inclusive definition of promotion ensures that Article 8 products do not have to exclude any investment strategies, but they can integrate several already familiar tools and strategies used for responsible investing to their processes, such as ESG integration and active ownership ESG screening, exclusion strategies, and thematic investing.
In conclusion, financial market participants should consider the impression they give to the investors. In other words, if the financial market participant provides in any document related to the financial product in any form an impression that investments pursued by the financial product also consider environmental or social characteristics, the product ought to be classified as an Article 8 product, and therefore, follow the disclosure obligations of this category. However, due to the two-sided meaning of promotion, in order to comply with the objective of SFDR, if the financial product is classified as Article 8, it should advance the ESG factors the financial product has chosen to promote.
What differentiates Article 8 products from Article 6 and 9 products?
The idea of the classification system is to separate the financial products in different categories based on their ambition level in sustainability. However, since Article 8 products may include a wide variety of financial products with different levels of ambition, it may be difficult to estimate if a particular product is sufficient to be classified as Article 8 or if it could already be an Article 9 product.
What are the key differences to look at? What differentiates Article 8 financial products from Article 6, is the promotion of E&S characters described above. The mandatory integration of sustainability risks into the investment decision-making is therefore not sufficient to form an Article 8 financial product.2
Separating Article 8 products from Article 9 financial products can be more difficult, since Article 8 financial products may also make sustainable investments. However, the EU Commission has stated that Article 8 financial products have a lower sustainability ambition than the Article 9 financial products. Another thing to consider is that Article 9 products need to comply with the “do no significant harm” principle. One key difference in this case is that products that do have environmental objectives but do not meet the do not significant harm criterion qualify as Article 8 products.
2 sfdr_ec_qa_1313978.pdf (europa.eu), s. 8.
SFDR’s disclosure obligations provide positive opportunities to fund managers. Harmonizing sustainability disclosure obligations improves fair competition and creates a “level playing field”. It also provides competitive advantage to fund managers who take sustainability seriously and are now able to show the work they do to the investors in a comparable and transparent format.
Lastly, since the Article 8 leaves the possibilities to promote E&S characters wide open, the SFDR also allows combining the information collected due to mandatory disclosures to the financial product disclosures. One of these overlaps seems to be principal adverse impact (PAI) reporting and Article 8 financial product promotion. The quite fresh Commission draft technical regulatory standards have directly stated that taking PAI into account in investment decisions can be a way of promoting ESG factors. If you wish to learn more about PAI and how to implement them in your organization, stay tuned in our blog or contact our professionals for assistance.
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