[1] In June 2024, the European Supervisory Authorities (ESAs) issued a collaborative Opinion on the evaluation of the Sustainable Finance Disclosure Regulation (SFDR). This action followed the public and focused discussions launched by the European Commission (EC) in September 2023. Noting the hurdles arising from the SFDR‘s application, the ESAs’ Opinion suggests an enhanced and consistent sustainable finance structure. It does this by recommending a series of amendments to the current SFDR framework. 

The Opinion’s Status

The Opinion does not emanate directly from a designated tasking by the European Commission. Instead, it represents an independent report produced by the ESAs, albeit with the overarching review of the SFDR framework undertaken by the Commission. This review encompasses both the foundational (Level 1) and more detailed (Level 2) elements of the framework. 

In this context, it is important to note that the Opinion is not just an arbitrary document. Rather, it serves as a critical contributor to the ongoing discourse concerning the future evolution and strategic trajectory of the SFDR. It provides comprehensive insights and potential avenues for further development and improvement. 

However, it is pivotal to understand that despite its significance within the broader dialogue, the Opinion does not carry any legal binding force upon any given entity. It is offered as a point of reference, a source of informed discourse, but is not a legally enforceable directive or regulation. 

What Does The Opinion Cover?

Following up on the confusion around Article 8 and 9 of the SFDR being used as labels rather than disclosure indicators, the ESAs have put forward a new product classification system. This move is aimed at clearing up confusion for investors, especially those at the retail level, and reducing the risk of greenwashing.  

The new proposal suggests creating two categories: one for “sustainable” products that invest in green or socially conscious activities and assets; and a second “transition” category for products that are on their path towards sustainability. The level of disclosure, product naming, and marketing boundaries will be based on the product’s category. If a product doesn’t fit into either group, its sustainability features will be evaluated separately. 

The Opinion also highlighted the potential of incorporating a sustainability indicator into a scale. This would effectively display a product’s sustainable features, providing valuable information to investors. To ensure reliability, this indicator should be guided by transparent and objective guidelines during the creation of this grading scale and its applicable categories. The European Commission should consider whether this sustainability rating system will operate independently or with the newly proposed product classification system. Also, the EC should be mindful of the technical intricacies and possible difficulties that can emerge from this initiative. 

ESAs’ Recommendations To The Commission

Overall, the recommendations from ESAs revolve around nine central aspects, specifically: 

a) It may be beneficial for the Commission to demarcate a system of product classification, which is focused on regulatory categories or sustainability indicators. This would assist consumers in exploring the vast array of sustainable products, thus promoting a complete shift towards sustainable finance; 

b) The product categories should embody simplicity and have concrete, objective criteria to determine their classification. The ESAs suggest, at minimum, categories of ‘sustainability’ and ‘transition’; 

c) A sustainability indicator might highlight environmental or social sustainability, or both. This allows investors to visually gauge the sustainability aspects of a product on a scale; 

d) The Commission should consider consumer testing and consultation for product categorization and sustainability indicators. With these established, it reduces the need for detailed sustainability disclosures; 

e) The Commission could reassess the concurrent existence of “sustainable investment” as defined in the SFDR and Taxonomy-aligned investment per the EU Taxonomy. The EU Taxonomy is a scientific benchmark for measuring environmental sustainability, while the SFDR provides a less strict set of guidelines for sustainable investment assessment. A rework of the EU taxonomy to include social sustainability should be a priority; 

f) It is strongly suggested by the ESAs that the Commission ensures sustainability disclosures are tailored to suit various investor needs. This includes considering various distribution channels, including digital, and maintaining consistency of information. Essential information should be prioritized for retail investors, while detailed information would be beneficial for professional investors; 

g) The Commission should consider expanding the SFDR scope to other products for a uniform approach to disclosures across all products within the scope; 

h) The suitability of key adverse impact indicators for all financial products should be evaluated, with a cost-benefit analysis justifying this requirement; 

i) Lastly, the Commission could look at developing a framework for assessing the sustainability features of government bonds, keeping in mind their unique aspects.

Next Steps

At this moment, the future steps and schedule for any updates to the SFDR remain uncertain. The European Commission has not yet specified a precise timeline or detailed roadmap for the potential implementation of these recommendations. Stakeholders, including financial institutions, regulatory bodies, and investors, remain in anticipation of further guidance. Given the complex nature of these proposed changes and the necessity for thorough consultation and testing, it is anticipated that any revisions to the SFDR framework will undergo a comprehensive review process. Until more explicit directions are issued, entities impacted by the SFDR should stay informed and prepared to adapt to forthcoming changes based on the ongoing dialogue and successive communications from the Commission. 

References: 

[1] https://www.esma.europa.eu/sites/default/files/2024-06/JC_2024_06_Joint_ESAs_Opinion_on_SFDR.pdf