SFDR: Back to the Drawing Board?

September 26, 2023
  • Investor Services
The ESG disclosure regime has had a significant impact on funds in Europe since implementation in March 2021. Now, policymakers are reassessing.

Despite good intentions and vast resources applied to the Sustainable Finance Disclosure Regulation (SFDR), industry believes it could be revisited and reframed to make it more useful and less complex to investors. And policymakers have listened.

Here’s three key takeaways for fund managers:

  1. The European Commission has opened a formal review of SFDR by way of public consultation. The review indicates policymakers want to go back to the drawing board on the cornerstone regulation to its ESG financial services policy agenda
  2. The review proposes a shift to an increased level of prescription on validating fund sustainability in investor disclosures – policymakers originally intended it to be a disclosure regime; however, it became a fund labelling regime with the wider market focused primarily on whether a fund was article 6, 8 or 9
  3. The consultation opens the door to a shift to a sustainability labelling regime with defined fund labels based on a funds’ approach and level of conviction to sustainability

A Positive Step

The overarching theme of the consultation is one of repurposing the regime to make it more useful to market participants, improve interoperability with other regulations and be efficient in the use of resources to comply with it. It runs until December 15, 2023, and should garner a large scale and vocal response to a very influential fund regulation in Europe.

Industry should welcome the repurposing of the regime to make it more useful.

SFDR was a pioneering global ESG disclosure regulation that aimed to produce decision useful ESG disclosures to investors regarding the sustainability credentials of funds sold in the E.U. Since its implementation, SFDR has placed ESG considerations high on the agenda of fund manufacturers, distributors, and investors across the E.U. It has had a material impact on fund flows – funds with a higher ESG conviction have garnered more inflows than those funds not eschewing ESG principles.

However, it’s clear the regulation’s roll out has not been without issue. Policymakers categorically intended SFDR to be a disclosure regime but in practice it became a de facto “labelling” regime. The regime emphasized the SFDR designation and that participants could measure a funds’ ESG conviction by the SFDR article attached to it. This was never the intention of the regulation but here we are.

In Brief: A Wide-ranging Consultation

The consultation, like most E.U. ESG releases, is detailed and proposes changes to a wide range of areas. The E.U. also pragmatically appears to concede the first iteration of SFDR had challenges and policymakers appear to want to improve on “lessons learned” since the initial roll out. The consultation questions a wide array of SFDR focus areas ranging from reducing its complexity, improving the presentation of disclosures, assessing the costs in SFDR compliance, and the value to investors of entity level disclosures.

It also questions how SFDR interacts with other governing regulations such as the Markets in Financial Instruments Directive (MiFID) and Packaged Retail and Insurance-based Investment Products (PRIIPs). SFDR has cross pollinated the entire E.U. funds landscape with sustainability integrated into each of the major core regulations.

The proposal regarding a uniform disclosure regime for all products and fund labels are the most consequential shifts contained within the consultation. Industry will have mixed feelings on the introduction of fund labels, since this is what has happened in the market in practice. However, there has also been a significant number of resources, time, effort, and money spent on categorising funds into the existing SFDR articles. So, it will be interesting to see where this proposal lands.

Long Road Ahead

Since SFDR has been one of the most significant policy changes in Europe in recent years, responses to proposed changes will be interesting. Overall, industry will want to ensure the regulation is improved and that efforts already made to comply with SFDR can be leveraged for whatever comes next.

What is clear is that in Europe and elsewhere, ESG rulemaking remains in its infancy and comes with inherent complexities and challenges. Our industry remains very much in the initial stages of a long policy journey when it comes to regulation of sustainability.

Network of pins and threads in the shape of many interconnecting speech bubbles symbolizing social dialog
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