Three years after the implementation of the EU’s “Sustainable Finance Disclosure Regulation (SFDR)” legislation, confusion still reigns in the market. The classification of sustainable funds under SFDR, particularly Article 8 and Article 9 funds, remains unclear, leading to significant reclassifications by fund managers. A consultation conducted by the EU found divided opinions on whether the regulation has achieved its objectives. While there is support for transparency and the regulation at the EU level, there are concerns about legal clarity, the relevance of disclosure requirements, and the usefulness of the disclosures to investors. There is also a perception that SFDR is being used more as a labeling and marketing tool than as a disclosure framework.
One of the key challenges with SFDR lies in its ambitious objective of allocating capital to address environmental and social issues. The directive emphasizes the importance of impact and sustainability risks in financial decisions but falls short in addressing the tension between creating positive impact and avoiding harm to those objectives. The definition of “sustainable investment” highlights the focus on directing capital towards activities that contribute to environmental and social objectives. However, the lack of clarity around certain concepts and the absence of consideration for financial returns raise questions about the effectiveness of the regulation in achieving real-world impact.
While Article 8 funds have seen a significant increase in assets, Article 9 funds represent only a small percentage of European fund assets. This raises doubts about whether SFDR has successfully driven a substantial shift in corporate activity towards sustainability goals. There has been little assessment of whether SFDR has met the EU’s policy objectives of capital reallocation for a more sustainable economy. As the EU revisits SFDR, it will be essential to evaluate the success of the policy objectives and establish clear metrics for measuring impact.
The role of financial returns within SFDR is limited, with a focus on single materiality and a lack of consideration for impact materiality. The legislation does not address trade-offs between financial returns and sustainability objectives, raising questions about the practicality of achieving both simultaneously. Moving forward, the EU must carefully consider the policy objectives of SFDR, ensure the regulation is tailored to achieve those objectives, and assess the cost-benefit ratio. It is crucial to acknowledge that capital allocation is driven by returns and to manage expectations around the impact of disclosure alone. Balancing transparency, impact, and financial returns will be key in the future development of sustainable finance regulations.
