Insight

Will ESG fund labelling requirements kill SFDR?

Drought

The EU’s Sustainable Finance Disclosure Regulation (SFDR), which has been in place for about two years, has created notable gaps in understanding and compliance that ESMA is still struggling to fill. The regulator hosted a public hearing in late January 2023 to discuss fund labelling proposals designed to prevent greenwashing and protect investors from funds misrepresented as supporting ESG initiatives.

ESMA’s consultation period on fund naming guidelines concluded on 20 Feb 2023 and has already generated a significant amount of reaction from the industry, who warn that overly strict guidelines could undermine the intent of the regulation.

Indeed, funds are still struggling to appropriately adhere to SFDR updates that took effect in January 2023. According to ESMA’s analysis of nearly 30,000 EU-domiciled funds, an estimated 14%—or around 4,000 funds—use at least one ESG or sustainability-related word in the fund name. Asset managers use fund names as a marketing tool, and ESMA’s fears about the growing risk of greenwashing seemed supported by the 534 Article 6 funds with fund names that suggested ESG or sustainable investments.

What is SFDR and what are the proposed changes?

Broadly, SFDR is a disclosure requirement for funds relating to their sustainable investments. Under the regulation, a fund can be classified as belonging to one of three categories: Article 6 (no ESG/sustainability investments), Article 8 (some ESG/sustainability characteristics), or Article 9 (clear ESG/sustainability objectives).

Currently, there is no minimum proportion of ESG investments specified for Article 8 funds. But the recent consultation paper proposes stricter guidelines, including:

  • Minimum safeguards (exclusions) based on Paris-aligned benchmarks for all funds using ESG and sustainability terms in the name
  • 80% investment threshold (in terms of environmental or social characteristics or sustainable investment objectives) for funds with ESG and related terms in the name
  • Additional 50% threshold (sustainable investments as defined by Article 2(17) of SFDR) for funds named using sustainability-related terms
  • Specific funds (index and impact funds) included
  • Transitional period of six months for existing funds

The widespread impact of proposed fund labelling rules

The proposed thresholds would potentially impact an estimated 2,730 funds currently disclosing under Article 8 SFDR. Adding to the confusion is the retroactive requirement issued in May 2022 for pre-SFDR Article 8/9 funds to adhere to SFDR’s website and periodic disclosures. The precedent of applying current wisdom to previous periods has made fundraising more difficult for many fund managers already, and those disclosing under Article 8 may soon have an even greater barrier.

Among the benefits cited by the EU regulator are easily understood thresholds, upholding standards to meet investor expectations, and minimising the perception of ‘downgrading’ funds’ disclosures from Article 9 to Article 8 by reinforcing consumer confidence in Article 8 funds.

The outcomes of this most recent consultation period are expected in Q3 2023, with a proposed six-month transition period after the three-month period from when the guidelines have been published.

If you need help navigating SFDR in any form—today’s or tomorrow’s—contact our team today. We are experts at helping firms navigate regulatory complexity in record time.