EU Sustainable Finance Disclosure (SFDR) taking a new direction? What to expect for the financial services' industry main disclosure regime in 2025 and beyond

As part of the EU Sustainable Finance framework, the EU Sustainable Finance Disclosure Regulation (Regulation (EU) 2019/2088, SFDR) was intended to channel private capital into more sustainable investments and thus support the Green Deal. It was accompanied by extensive implementing provisions. However, less than four years later, the market's view on SFDR is fairly gloomy. Sustainable funds have recently experienced massive outflows, certainly also triggered by the current market situation. In addition, many providers and investors point to the complexity of regulation and the breathtaking pace at which rules are being set. Until the summer break in 2024, seemingly each week a new opinion, statement or commentary was published on how the EU Sustainable Finance Framework should develop or be interpreted. 

In addition, the EU Commission and regulators are pursuing different objectives with SFDR. The EU Commission has opted for a principles-based and open approach in order to mobilise private capital for the Green Deal. The regulator's core focus is to protect investors from false or misleading statements on sustainability. At the end of May 2024, the European Supervisory Authorities (ESAs) presented their final reports on Greenwashing in the financial sector and called on the national regulators to take action. The French Autorité des Marchés Financiers (AMF) has already imposed its first fine on a property manager for failing to comply with the investment guidelines described in its disclosures.

The deliberately broad concept of SFDR, which is detached from investment strategies and has two sustainable disclosure categories – Article 9 for very sustainable products and Article 8 for all other sustainability-related products – no longer seems up to date. More current frameworks such as the SDR regime in the UK or the self-regulation of the Swiss Asset Management Association AMAS instead are oriented at investment strategies and themes. In addition, there is a great demand for labels, i.e. product categories with objective minimum standards, at least for private investors. However, SFDR has deliberately not been built to work as a labelling regime.

Consultations on the SFDR framework

Last year, two consultations have been run on SFDR: one by the EU Commission to further develop the regulation itself and one by the ESAs to supplement SFDR's implementing provisions (SFDR RTS). The latter was concluded in December 2023 with a recommendation to the EU Commission, which has not yet been taken up.

Part 1 of the EU Commission's consultation posed questions on improving the regulatory framework, for example on further requirements for sustainable investments and on whether Principal Adverse Impacts (PAI) should only be reported if they are material. Part 2 contained ideas on the introduction of product categories (labels), either as a further development of the existing disclosure categories or with four new, theme-based product categories (solutions to sustainability-related problems, compliance with sustainability standards, exclusions and transition).

The response to the EU Commission's consultation on the further development of SFDR was overwhelming: more than 320 responses from the financial sector, NGOs, national regulators, ESG data providers, companies from the real economy and academia, mainly from the EU, but also from other countries such as the UK and the US. According to the evaluation published in May 2024, many consultation participants gave the SFDR poor grades: 84% did not consider the disclosures to be suitable for providing investors with adequate information. 82% saw a need for further clarification on key concepts such as sustainable investment. Unsurprisingly, more than 75% were in favour of the introduction of product categories (labels).   

Regulators issuing own proposals

Even after the end of the consultations, the discussions continued. Some national regulators have published their own ideas for the further development of SFDR. The first of these was the Dutch Autoriteit Financiele Markten (AFM) who suggested disclosures for all financial products and the introduction of three sustainable product categories in November 2023. These categories should cover investments in transformation, in generally sustainable activities and in activities with a specific impact. At the end of February 2024, the Dutch AFM was joined by the French AMF who proposed the introduction of four product categories, namely environmental solutions based on the EU Taxonomy, social solutions (based on a social taxonomy yet to be developed), climate transformation with a focus on decarbonisation and the application of non-financial filters based on ESG ratings. In July 2024, the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) called on the new EU Commission to simplify the regulatory framework and clearly define sustainable investments. BaFin wanted three product categories - one for investing in already sustainable activities, one for investing in the transition and one in which certain activities are excluded.

Shortly after BaFin, the European Securities and Markets Authority (ESMA) published its view on the long-term development of the EU Sustainable Finance regulations. Like AMF, ESMA called for the EU Taxonomy being the only framework defining sustainable investing. However, ESMA recognized that the current EU Taxonomy is still far too limited to fulfil this function. According to ESMA, the new EU Commission should therefore prioritise the completion of the EU Taxonomy. In addition, ESMA called for a separate category of transformational investments to promote the Green Deal. Finally, ESMA emphasized the aspect of investor protection and called for disclosures and product categories better adapted to private investor needs. Such product categories could then be voluntary and be destined at private investors, as in the UK. 

All eyes are on Brussels

It is up to the new EU Commission to take up the numerous proposals from November 2024. The designated Financial Services Commissioner Maria Luís Albuquerque has confirmed in her hearing by the EU Parliament on 6 November 2024 that she wants to transform SFDR into a product categorisation system with clear criteria. She also mentioned that she wants to focus more on directing private capital into projects with a positive environmental and social impact, including investments in the economic transition which are currently not adequately represented in the EU Sustainable Finance framework. Interestingly, she did not mention the extension of the EU Taxonomy called for by ESMA, AMF and other regulators.

In times of political turmoil, a stagnating economy and increasing external threats, it is doubtful that the EU Commission will place the further development of SFDR at the top of its priorities list, even if ESMA hopes for a revision by mid-2025. One thing is already clear: in the EU Commission President's second term of office, the focus of the EU Sustainable Finance framework will be on clarifying and simplifying the existing rules. Aside from a few projects that have been left undone, such as the final adoption of the already negotiated EU ESG Rating Regulation, it is likely that we will not see significant new projects in the next years. However, it is too early to celebrate for legal and compliance departments in the financial sector, as the simplifications, adjustments and clarifications that have been announced must also be implemented in a legally compliant manner.

Limited scope of action

EU and national regulators would prefer to put their ideas into practice rather today than tomorrow, but they lack the legislative powers to do so. With its guidelines for ESG or sustainability-related fund names, which will apply from November 2024, ESMA has already introduced a kind of mini-label (see here and here). However, its scope is limited because ESMA is only allowed to set rules for funds that have certain sustainability-related terms in their name, such as "green", "ESG" or "impact".

The hope repeatedly expressed in the market that SFDR could be dropped or fundamentally amended in the short term is unlikely to realize any time soon. Even if the new EU Commission proposes changes sooner than expected, these will first have to survive the lengthy EU legislative process. Moreover, the financial services industry hopes the new rules will be accompanied by implementation deadlines permitting them to implement the changes in a reasonable timeframe. The financial sector will therefore have to live with the current SFDR and its shortcomings for a little longer.