The European Commission’s review of SFDR

The European Commission has launched a wide-ranging consultation on the Sustainable Finance Disclosure Regulation (SFDR). It represents a fundamental review of the regulation, which originally came into force in March 2021. 

The consultation is a preliminary information gathering exercise rather than a detailed consultation on specific rules. It seeks to capture views on the usefulness and compatibility of the current rules, and possible changes to the disclosure requirements, including to capture Article 6 funds. It also explores significant changes that would fundamentally revisit the structure of the regulation, including the possibility of bolstering the existing Article 8/9 disclosure requirements, or most strikingly of all, to remove them altogether in favour of new categories.

The consultation follows calls from some EU regulators, such as the AMF, to introduce minimum standards for Article 8 and 9 products. It is the latest stage in the evolution of the SFDR, which has been widely regarded by industry and regulators as a work in progress — see a summary of previous developments here.

Areas explored in the consultation

The consultation aims to gather views in the following areas:

1) Current SFDR requirements

This section aims to gather views on how well SFDR works in practice and potential issues. The questions capture the appropriateness and usability of the Principal Adverse Impact (PAI) disclosures, the costs and benefits of complying with the regime, and the challenges associated with data gaps. This section also seeks to understand whether firms have increased their offering of financial products that make sustainability claims since SFDR was introduced, and, if so, the drivers behind this.

2) Interactions between SFDR and other EU sustainable finance rules

Questions in this section focus on alignment, misalignment and inconsistencies between the SFDR and other regulations. These include the Taxonomy Regulation (e.g. on the definition of a sustainable investment/sustainable activities and the DNSH¹ tests), the Benchmarks Regulation, MiFID II² (e.g. on sustainability preferences), CSRD³, IDD⁴ and PRIIPs⁵ (e.g. on disclosures proposed under the Commission's retail investment strategy). The questions also seek views on the Commission's most recent Q&A clarifications — e.g. on the definition of a sustainable investment and the status of index-tracking products. 

3) Potential changes to the disclosure requirements

As well as exploring the format and presentation of the disclosures, views are sought on their content:

• Entity-level disclosures: The questions ask whether these disclosures are useful overall, which PAI indicators are most useful, whether SFDR is the right place for entity-level disclosures, and whether there is scope to streamline entity-level disclosures across regulations.
  
• Product-level disclosures: Interestingly, the Commission asks whether standardised product disclosures should apply to all products, regardless of their claims (i.e. to also include Article 6 funds). In that scenario, it asks which PAIs should be disclosed, whether there should be an element of proportionality (e.g. based on size), and which factors should trigger reporting obligations.
  

4) Potential establishment of a categorisation system for financial products

Most strikingly, the Commission explores whether new product categories should be introduced, based on sustainability objectives and precise criteria. The questions address the potential usefulness and effectiveness of such an approach, and how any categories should be designed. Two possibilities are put forward:

A) A fundamentally different approach: This could include new categories based on a product's investment strategy, which would result in the Article 8/9 approach being dismantled. The Commission suggests four potential categories, which are similar to the FCA's proposed labels under SDR (see below), and poses more detailed questions on:

1. Whether there is merit in distinguishing between social and environmental products;
2. The optimal number of categories;
3. Whether they should be mutually exclusive (like the FCA labels);
4. Potential minimum criteria;
5. Monitoring KPIs; and
6. How to transition from the current Article 8/9 regime.

B) Converting Article 8 and 9 into formal product categories and adding criteria: The Commission asks about the optimal way to do this, including building on the existing concepts of promoting environmental/social characteristics or a sustainable investment. It also considers alternative approaches to the definition of a sustainable investment, whether minimum taxonomy-alignment should be prescribed, and adapting the concept of good governance.

Across both options, the Commission seeks feedback on whether there should be additional disclosure requirements, the governance system around the disclosures, whether third party verification should be required, and broader considerations. Wider interactions are also discussed, such as with proposed disclosures in the PRIIPs KID, with sustainability preferences, and, lastly, with potential rules regarding naming and marketing communications (see more below).

Comparison with the FCA's SDR proposals

There are several areas of the consultation that appear to have been influenced by the FCA's proposals for Sustainability Disclosure Requirements (see how UK firms can approach these here). For example, requiring limited disclosures of Article 6 products, the potential product categories, and naming and marketing rules. 

Under Option A above, the possible product categories closely resemble the labels consulted on by the FCA. Given the substantive differences between SFDR in its current form, and SDR (as proposed), the Commission's suggestions are likely to interest asset managers with cross border operations, although there will be some reservations (see below):

The Commission has questions on whether the above categories should be accompanied by naming and marketing rules — i.e. if a product does not meet one of the categories, then it could be prevented from using terms such as “ESG” or “sustainable”. Such an approach would overlap strongly with the FCA's latest proposals.

Implications

Given the various challenges that have been experienced with the SFDR, asset managers are likely to have mixed responses to the consultation. Firms have spent three years entirely overhauling their investment processes, product strategies and reporting operating models to comply with the SFDR in its current form — and therefore may be concerned about the scale of change that the Commission is contemplating.

Given some of the fundamental questions being posed, there could also be significant implications for the ESAs' parallel consultation on the SFDR delegated regulation and ESMA's proposed guidelines on fund names, both of which rely on the existing Article 8 and 9 disclosure categories. In addition, it is not clear whether a revised SFDR would replace proposals for an EU Ecolabel, which are currently on hold.

There are no immediate impacts on firms, but they are encouraged to take the opportunity to feedback on the Commission's questions by 15 December.

More broadly, it is notable that the Commission appears to be drawing heavily on the UK's proposed approach as it considers its next steps, illustrating that the UK may not be destined to be a “rule-taker”.