Stockholm (NordSIP) – The sustainable investment industry has clearly been suffering from growing pains in recent months. Fund classification frameworks and sustainable finance taxonomies are a work-in-progress, while market practitioners scramble to keep up. This has led to growing confusion and scepticism from investors, potential reputational risks for asset managers and even the risk of litigation when products may have been wrongly categorised. In an effort to untangle the situation, Eurosif – the partnership of Europe-based national Sustainable Investment Forums (SIFs) – has published a new report proposing significant changes to Sustainable Finance Disclosure Regulation (SFDR) product classification.
Eurosif’s report, entitled EU sustainable Finance & SFDR: making the framework fit for purpose was published on June 28, 2022. The organisation’s main argument is that the SFDR, which by definition was designed as a disclosure framework, has also been adopted by the market as a de facto fund classification system for marketing purposes. According to Eurosif, “SFDR provisions do not make clear how to qualify a product as Article 6, 8 or 9, or where the boundary between these product categories lies, forcing many market participants to classify and self-certify their own products.” They propose a pragmatic solution involving tweaking the SFDR to match the market reality rather than unwinding the situation and building a separate fund classification system.
The report offers up an overview of the European fund market since SFDR was introduced. Article 8 and 9 funds account for just under half of the funds on sale within the EU in terms of asset size. Roughly half of all new fund launches are also within these categories, reflecting healthy demand from asset owners. Eurosif highlights the fact that the SFDR categories were designed as deliberately broad to capture the maximum amount of data via the related reporting. This, along with the SFDR’s imprecise definition of sustainable investment, has compelled asset managers to develop their own classification methodologies based on their interpretation of the criteria. The result is a proliferation of discrepancies, as evidenced by the examples in the report of Article 9 funds with significant exposure to thermal coal. Another issue that is raised is that of existing products being tweaked to fit disclosure requirements without meaningful changes being reflected in the underlying portfolios.
Despite these problems, Eurosif acknowledges that the SFDR product categories have inadvertently filled a strong need in the sustainable investment market for a common language. The rapid adoption of the Article 6, 8 and 9 structure has caused national regulators to begin providing their own guidance, and Eurosif believes there is a risk of fragmentation if that continues. They are thus advocating for timely amendments to the existing disclosure structure to make it “fit for purpose” as a product classification system. Eurosif would like to see either a new category or amendments to the current Article 6 definition to accommodate funds that only consider ESG factors in pure financial materiality terms. They also accept that Article 8 should remain broad, but advocate the introduction of more precise, binding non-financial objectives along with greater evidence required at all stages of the engagement process with portfolio companies. At the same time, Eurosif underlines the importance not just of transparency but also simplicity when categorising products for the retail market.
The pragmatic approach adopted by Eurosif, based on market realities, appears to be a sensible contribution towards solving the teething problems faced by the sustainable investment industry. NordSIP would certainly recommend reading through this report, which provides a useful overview of the current situation along with its recommendations. Many of the proposed changes would depend on significant work being done by policymakers, and there remain a few unanswered questions. Eurosif are hopeful that the recommendations in their report will be considered by the European Commission as it works towards the evaluation of SFDR due before the end of the year.