The European Union is preparing to introduce the most significant reforms to its sustainable finance framework since the original Sustainable Finance Disclosure Regulation (SFDR) entered into force in 2021. Following nearly two years of review, the European Commission has tabled a proposal, commonly referred to as SFDR 2.0, that would reshape how sustainability-related financial products are categorised, labelled and disclosed across the EU financial system. [1][2][3][5]

Driven by widespread concerns about complexity, inconsistent classifications and rising greenwashing risks under the current framework, the reforms aim to transform SFDR from a loosely structured disclosure regime into a clear product categorisation system designed to help investors, especially retail savers, make more informed and comparable decisions. This structural shift aligns with the EU’s broader agenda to enhance trust, transparency and capital mobilisation for climate and environmental priorities, reinforcing goals already seen in related policy reforms.

1. Why SFDR Is Being Reformed

The European Commission’s comprehensive review reached an unequivocal conclusion: the SFDR is not working as intended. According to the Commission, the regulation’s disclosure templates have become overly long, legalistic and difficult for retail and even professional investors to interpret. [2][3]

Three particular issues justified reform:

1.1 SFDR became a de facto labelling regime

Although SFDR was designed as a disclosure framework, the market rapidly adopted its Article 8 (“promotes ESG characteristics”) and Article 9 (“sustainable objective”) classifications as labels. This created a perception that Article 8 funds were “light green” and Article 9 funds “dark green”, prompting asset managers to rely heavily on these terms in product names and marketing, often inconsistently. [1][2][4][5]

1.2 Disclosures became too complex and burdensome

Asset managers struggled with extensive templates and dozens of mandatory indicators. Many investors also found the resulting reports too long and too technical to meaningfully compare funds. [2][3]

1.3 Risk of greenwashing increased

Flexible interpretations of key terms, particularly “sustainable investment”, meant that funds with limited sustainability ambition could still claim Article 8 or even Article 9 status. In the most controversial examples, fossil fuel developers appeared in Article 9 funds, undermining trust in sustainable fund classification. [4]

In light of these shortcomings, the Commission’s proposal seeks to “reset” the system, delivering a simpler, more usable regime that improves comparability while reducing compliance burdens on financial market participants. [2][3]

2. SFDR 2.0: The New Product Categorisation System

The centrepiece of SFDR 2.0 is a three-tier product categorisation regime designed to replace Articles 8 and 9. Only products falling within one of these categories will be permitted to use sustainability terminology in their marketing. [1][2][5]

The three proposed categories are:

1. Sustainable
2. Transition
3. ESG Basics

Each category comes with minimum investment thresholds, portfolio-wide exclusions, and product-level disclosure requirements. The categories reflect a wide consultation process, including feedback that existing SFDR classifications were too open to interpretation.

2.1 Sustainable Category

Funds in this category must invest in companies or projects already contributing to environmental or social sustainability goals, such as climate mitigation, biodiversity protection or positive social outcomes. These products target assets that are aligned with high sustainability standards today. [2][5]

2.2 Transition Category

This newly introduced category recognises the need to finance companies or assets that are not yet sustainable but are demonstrably on a credible transition path. These products support improvements in emissions, environmental impacts or social performance. [1][2][5]

Crucially, the transition category includes explicit exclusions for companies expanding fossil fuel activities and for those lacking a credible plan to phase out fossil fuel exposure. [4][5]

2.3 ESG Basics Category

This third category captures products that incorporate ESG considerations, such as best-in-class screening or exclusions of worst performers, but that do not aim for full alignment with sustainability or transition strategies. [1][2][5]

The ESG Basics category has more limited exclusion rules, and stakeholders warn this may still allow funds with relatively weak sustainability profiles to qualify, depending on final delegated acts. [4][5]

3. Minimum Thresholds and Portfolio Exclusions

All three categories share key structural requirements intended to strengthen the credibility of sustainability claims.

3.1 Minimum 70% Asset Alignment

For any product seeking categorisation, at least 70% of its portfolio must support the category’s stated strategy, whether sustainable, transition or ESG-based. The remaining portion may be used for liquidity, hedging or diversification, provided these holdings do not undermine the product’s sustainability profile. [1][4][5]

3.2 Core Exclusions Across All Categories

All categorised funds must exclude companies involved in:

• controversial weapons,
• tobacco,
• severe breaches of human rights and international norms,
• certain fossil fuel activities beyond predefined limits. [2][4][5]

The Sustainable and Transition categories carry stricter fossil fuel-related exclusions than ESG Basics, reflecting different sustainability ambition levels. [4][5]

4. Table: Overview of SFDR 2.0 Proposed Categories

Category	Primary Aim	Key Features
Sustainable	Invest in assets already contributing to sustainability goals. [2][5]	≥70% aligned holdings; strict exclusions including fossil fuel expansion; high sustainability performance. [4][5]
Transition	Support companies on credible pathways toward sustainability. [1][2][5]	≥70% aligned holdings; excludes fossil fuel developers and firms without phase-out plans; measurable transition progress.
ESG Basics	Integrate ESG approaches without full sustainability alignment. [1][2][5]	≥70% aligned holdings; baseline exclusions; flexible ESG methodologies.

5. Simplifying Disclosures: A Focus on Product-Level Information

Another cornerstone of SFDR 2.0 is disclosure simplification.

5.1 Removal of Entity-Level PAI Reporting

The proposal eliminates entity-level Principal Adverse Impact (PAI) statements, which required asset managers to aggregate sustainability impacts across their entire organisation. This reporting had proven one of the most burdensome and data-intensive features of SFDR. [1][2][4][5]

Instead:

• only categorised funds (Sustainable and Transition) will need to disclose PAIs at product level;
• entity-level impacts will be disclosed only by the largest firms under CSRD, reducing duplication and aligning regulatory frameworks. [2][3]

This consolidation supports the Commission’s aim to reduce costs and eliminate duplicative reporting obligations.

5.2 Streamlined Product Templates

Product-level disclosures will remain mandatory for funds in the three categories but will be shorter, more targeted and more easily comparable. Templates will focus on:

• how the fund meets the category criteria;
• how the 70% threshold is achieved;
• which exclusions apply;
• key sustainability indicators relevant to the category. [1][2][3]

The simplification aims to make sustainability information more digestible for retail investors.

6. Risks and Concerns: Transparency and Greenwashing

While many stakeholders welcome the clarity offered by a structured labelling regime, several concerns remain.

6.1 Transparency “Cliff Edge” Risk

Because detailed disclosures apply only to categorised funds, non-categorised funds will provide far less sustainability information, even if they invest responsibly or apply ESG integration. [1][4][5]

This raises a transparency concern: investors may lose visibility over a significant part of the market if many existing Article 8 funds choose not to pursue a category label under SFDR 2.0.

6.2 Challenges for the ESG Basics Category

Some analysts argue that the ESG Basics category may be too broad and could allow products with very limited sustainability commitment to retain an ESG label. [4][5]

6.3 Fossil Fuel Exclusions and Label Integrity

Under SFDR 1.0, fossil fuel developers appeared even in Article 9 products. The more stringent exclusion frameworks for Sustainable and Transition categories help address this but concerns remain about potential loopholes depending on how delegated acts define thresholds. [4][5]

7. Implications for Asset Managers

Asset managers preparing for SFDR 2.0 will need to:

• evaluate whether existing funds can meet Sustainable, Transition or ESG Basics category criteria;
• ensure portfolios meet the 70% minimum strategy alignment;
• update processes for fossil fuel exclusions and credible transition plans;
• redesign product disclosures in line with simplified requirements;
• prepare ahead of the expected 2027–2028 implementation period. [1][2][5]

Stakeholders widely agree that the transition will involve substantial operational adjustments. As one industry expert put it, “the ball is now in the asset manager’s court.” [5]

8. Conclusion: A Clearer, More Credible Framework—If Implementation Holds

SFDR 2.0 represents a decisive attempt to reorient Europe’s sustainable finance landscape toward clarity, comparability and consumer protection. The proposed product categories aim to give retail investors intuitive, robust sustainability labels, while simplified disclosures should reduce compliance burdens and minimise opportunities for greenwashing.

However, the success of the framework will depend heavily on:

• the strength and precision of subsequent delegated acts,
• the willingness of asset managers to embrace the categories, and
• the ability to maintain market-wide transparency while tightening rules for sustainability claims.

As SFDR 2.0 progresses through the legislative process in the European Parliament and Council, asset managers and asset owners alike will closely monitor how the final framework balances usability, credibility and practicality, a balance essential to Europe’s ambition to lead the global sustainable finance agenda.

Sources

[1] KnowESG. Understanding SFDR 2.0: New EU Product Categorisation Rules. https://knowesg.com/reporting-standards/understanding-sfdr-2-0-new-eu-product-categorisation-rules

[2] European Commission. Amendments to the Sustainable Finance Disclosure Regulation (Press Release IP_25_2736). https://ec.europa.eu/commission/presscorner/detail/en/ip_25_2736

[3] European Commission. Commission Simplifies Transparency Rules for Sustainable Financial Products. https://finance.ec.europa.eu/publications/commission-simplifies-transparency-rules-sustainable-financial-products_en

[4] Institute for Energy Economics and Financial Analysis (IEEFA). SFDR 2.0: Making Labels Work for the Consumer. https://ieefa.org/resources/sfdr-20-making-labels-work-consumer

[5] Net Zero Investor. SFDR 2.0: Proposal to Revamp Sustainable Fund Labels. https://www.netzeroinvestor.net/news-and-views/sfdr-2.0-european-commission-sets-out-proposal-to-revamp-sustainable-fund-labels