The EU’s Sustainable Finance Disclosure Regulation (SFDR) legislation went into force in March 2021, aiming to prevent fund “greenwashing” and shift capital to support the EU’s “Green Deal” goal of becoming carbon neutral by 2050. However, three years later, there is confusion surrounding how to categorize sustainable funds under SFDR. The ambiguity in defining Article 8 and Article 9 funds has led to fund managers seeking legal help to determine their fund classifications.
The lack of clarity has resulted in market confusion, with fund managers frequently changing their fund classifications. A significant number of funds have been downgraded or upgraded in the past quarter, leading to uncertainty in the market. As a response to this confusion, Mairead McGuinness, Commissioner for Financial Services, Financial Stability and Capital Markets Union, announced a three-month consultation with stakeholders to assess the effectiveness of the SFDR.
The consultation found widespread support for the objectives of the SFDR but divided opinions on its effectiveness. While 89% of respondents believe that transparency through sustainability disclosures is essential, many feel that the current framework is unclear and lacks relevant disclosure requirements. The majority of respondents also do not find the costs of compliance to be proportionate to the benefits generated, highlighting the need for clarity and transparency in the legislation.
Despite the support for transparency, there is tension around the issue as stakeholders disagree on the best way forward. The complex legislation was overly ambitious in terms of capital allocation, prompting the need for a reassessment of its purpose and intended impacts. The lack of clarity on key concepts, such as sustainable investment, and the focus on positive impact without addressing potential negative externalities pose challenges for the effectiveness of SFDR.
While Article 8 funds have seen an increase in European fund assets, Article 9 funds remain low, indicating a limited real-world impact of SFDR in driving capital allocation towards sustainability goals. The legislation’s focus on impact materiality rather than financial returns raises questions about its effectiveness in achieving its policy objectives. As the EU revisits SFDR, it must consider the cost-benefit ratio, the measurement of success, and the integration of financial returns within the framework.
Moving forward, the EU needs to clarify the policy objectives of SFDR, ensure achievable impacts through fund disclosure, address the cost-benefit ratio, and measure the legislation’s effectiveness. While disclosure is important, it should not be expected to drive significant changes in capital allocation on its own. The EU must carefully tailor the legislation to achieve its intended impacts while considering the realities of financial markets and returns.
