SFDR review responses: Go further with mandatory disclosures and formalise fund labelling

Industry at odds over whether it's appropriate to ditch Article 8 and 9 'labels'

Clear mandatory disclosure requirements and alignment with the Corporate Sustainability Reporting Directive (CSRD) were common requests to the European Commission in responses to its Sustainable Financial Disclosure Regulation (SFDR) review.

However, asset managers and investment firms offer up differing opinions on how the EU should approach fund labelling and categories.

In September last year, the European Commission announced a consultation into how SFDR is implemented and whether to build out Articles 8 and 9 into fund labels or create new, investment strategy-based labels.

This follows wide criticism that a large number of Article 8 and 9 funds – considered the ‘greenest’ of the classifications – were significantly exposed to fossil fuel expansion and/or not aligned with the EU taxonomy, leading to claims of greenwashing.

Towards the end of 2022, a wave of Article 9 funds were downgraded to Article 8 ahead of the Level 2 regulatory standards taking effect at the start of 2023. Fund providers took the precaution of downgrading funds as it became understood Article 9 funds needed to be 100% invested in sustainable securities, but commentators have cited a lack of clarity around the classification and disclosures as a continued source of confusion.

See also: – SFDR overhaul: What the EU Commission should include

“It has become evident that the current system has created complexity and has not fully met the original objectives of the Commission, particularly in relation to funding transition and through being used as a labelling regime by market participants,” commented Jenn-Hui Tan, chief sustainability officer at Fidelity International.

In response to the Commission’s consultation, which closed on 15 December, a high number of companies called for further mandatory disclosure requirements in addition to the principal adverse impacts (PAIs) that financial market participants currently need to disclose at the entity level under SFDR Level 2.

Morningstar also questioned the relevance of the entity level disclosures. In the firm’s response, Arthur Carabia, director of ESG policy research, wrote: “In its current form, we have concerns that entity-level PAI reporting does not serve any use case or investor decision-making. Information that some investors would consider relevant at entity level, which is not already covered by CSRD, includes stewardship strategy.”

Groups called for SFDR to go further with mandatory disclosures – in line with other sustainable investment regulation such as the upcoming CSRD – and also mandatory product disclosures around the taxonomy, engagement and exclusions.

In its response, asset manager Mirova endorses the Commission’s plan “to broaden the scope of sustainability disclosures for all products regardless of categorisation.”

“This includes establishing shared minimum transparency standards related to environmental and social impacts. Only by doing so can we trust that institutional or retail investors will make fully informed investment decisions.”

The group said minimum disclosure requirements could be linked to existing tools and regulations, including exposure to sensitive activities or practices – again highlighting the need for an alignment with CSRD.

“These minimum disclosure requirements should be applied across all financial products, with additional requirements for funds with sustainability objectives,” Mirova’s response said. “This approach will ensure that all financial products meet the minimum disclosure standards, while also addressing the unique sustainability objectives associated with each product category.”

See also: – Lack of joined-up thinking on EU sustainability disclosures

Mixed views on approach to fund labels

SFDR’s initial mandate was not focused on labels when it was implemented in March 2021, however industry responses highlighted the way that Article 6, 8 and 9 have been adopted as fund labels, flagging the need for a system that offers investors transparency. The European Commission has proposed two options; the establishment of a new categorisation system (Category A [Impact], Category B [Focus], Category C [Exclusions], Category D [Transition or Improvers]) or converting Article 8 and 9 into formal product categories.

Despite agreement around the need for a more formal way to distinguish funds, the industry responses differed in their ideas of how this might look.

Fidelity’s Tan said: “[Our proposal includes] funds can opt for one of four sustainability labels, each with different requirements: Thematic/Leaders (Focus), Transition (Improvers), Impact and ESG Tilt​.

“Each fund with a sustainable label will state a clear objective, a strategy for achieving it and have binding characteristics.”

He added the ‘ESG Tilt’ label “offers space for medium sustainability intensity funds which meet minimum standards, e.g. invest in best-in-class ESG securities​”, while the three other labels represent “high sustainability intensity funds (i.e. “dark green” type funds, both environmental and social) will have additional requirements to reflect their type”.

Morningstar also said it was in favour of splitting categories in a way that differs from the existing Article 8 and 9 concepts.

Carabia wrote: “Currently, the Article 8/9 divide does not reflect the variety of investment strategies in use. According to Morningstar data, currently almost 11,000 funds are classified as Article 8 and 1,000 are classified as Article 9. Arguably, Article 8 is a catch-all group comprising funds with different ESG approaches and levels of ambition (for example, best-in-class, exclusions, tilts). Likewise, the Article 9 cohort includes a variety of strategies (for example, impact, thematic, climate objectives). We see merit in exploring more refined categories in order to help investors better navigate the current landscape.”

He added Morningstar encourages the EU to ensure “meaningful thresholds” for the fund labels are included, referencing the UK’s Sustainability Disclosure Requirements (SDR) label called ‘Sustainable Focus’ that requires 70% of the fund be invested in sustainable assets.

“For Categories B and D, we would therefore suggest that a minimum of 70% of the portfolio should be invested in top taxonomy performers according to the investment universe of the fund (for example, 70th percentile).”

He added Morningstar supports the broad outline of the proposed labels, which should be “non-hierarchical and mutually exclusive”, and also argued the proposed labels should be “optional at this stage”.

In its response, the UK Sustainable Investment and Finance Association (UKSIF) also welcomed a “marked shift from reliance on Articles 6, 8, and 9 as de-facto fund labels in the market, which has contributed to greenwashing risks for end investors.”

It called for clearer recognition of transition strategies and investments as “critical” in light of the urgent need to transition the whole economy towards net zero, and also urged the Commission to consider the UK’s SDR and other region’s approaches.

See also: – Should all ESG funds get labels?

“While naturally we expect there may be some nuances and differences across the EU’s and UK’s approaches to disclosures and fund labelling, we would strongly emphasise the need for continued close co-operation between our respective regulatory authorities, and across different jurisdictions, such as the US, Australia and elsewhere, as well as global standard-setting institutions, to promote harmonised approaches, and crucially consistency in the fund disclosures accessed by clients and savers in different markets.”

Mirova, meanwhile, urged caution in overhauling the product categories completely: “While we support the Commission’s proposal to introduce formal product categories, we see a risk with a ‘starting fresh’ strategy such as the four proposed categories which would also need to be clarified to be properly implemented (e.g., what could be considered as a “credible sustainability standard” in category B? What would be the definition of transition focus in category D?). Besides, as the categories cannot be mutually exclusive (products can use a mix of exclusions, transition and sustainable investments), this could result in a complex categorisation and hamper the clarity objective for end investors.”

Instead, Mirova called for a formalisation of Articles 8 and 9 as product categories and “establishing clear and specific criteria” as a more effective approach.

The outcome of the consultation is expected to be announced in 2024.


Natalie Kenway

Natalie is editor in chief at MA Financial covering ESG Clarity, Portfolio Adviser and International Adviser. She was previously global head of ESG insight for ESG Clarity and has been an investment journalist...