SFDR 2.0

The European Commission announced yet another round of sustainability reforms. This Proposal is nevertheless nothing like the Omnibus I and II packages released earlier this year, which try to streamline reporting rules mainly under the Corporate Sustainability Reporting Directive (CSRD) and the the Corporate Sustainability Due Diligence Directive (CSDDD). Importantly, these requirements concerned businesses, while on the investor side, things look very different.

Until now, the Sustainable Finance Disclosure Regulation (SFDR), which governs how financial products disclose their sustainability features has stayed mostly untouched. It appears that the new “SFDR 2.0” proposal doesn’t try to dismantle it, it tries to turn it into something more usable: clearer product categories, fewer overlapping disclosures and a better alignment with how investors actually work.

At the heart of the SFDR review sit three very concrete objectives:

Remove entity-level PAI disclosures

PAIs (principal adverse impacts) are the negative effects investments have on people and the environment, such as emissions, pollution or social violations. Under the new proposal, entity-level disclosures are deleted, while product-level disclosures remain.

In line with this amendment, financial advisers are removed from the scope of SFDR. This was done to clarify that the SFDR is primarily about product transparency, not about the advisory process itself.

The product-level PAI disclosures will also be injected with more flexibility. The Proposal hints at the possibility to disclose different indicators to those listed in the PAI framework if the product’s strategy justifies it.

The Commission acknowledges that a fund manager whose main focus is to increase its social impact has different reporting needs than one focused on climate mitigation innovation, for example. Therefore, materiality must be considered in the indicator selection process, and the PAIs should be a starting point rather than a limitation.

Simplify SFDR product-level disclosures

Right now, the SFDR templates are long, technical and often unhelpful for real people trying to choose a fund. The reform refocuses these disclosures on a smaller set of questions and indicators, tied directly to standardised product categories. The aim is to make it easier to compare products that market themselves as sustainable, and to cut recurring compliance costs by cutting down on noise.

New SFDR product categories

See the current product categories here. Under the proposal, funds will be able to qualify as:

• ‍Transition products (Article 7), steering capital towards assets that are not yet sustainable but are on a credible improvement paths
• ‍ESG basics products (Article 8), which systematically integrate environmental, social and governance factors into their investment process, without promising full sustainability. This would be the equivalent of the so-called Article 8+ products.
• ‍Sustainable products (Article 9), which invest primarily in assets that already meet high sustainability standards or that are clearly aligned with a     sustainability objective.

For each category, the framework sets out the main criteria that products have to meet, the types of assets they should not invest in (the exclusions), and the information that must be disclosed to investors.

At the same time, these articles are written to be flexible rather than rigid. The system is meant to be understandable and consistent with current practice, but not so prescriptive that it freezes innovation.

A new Article 9a is added to deal with funds that invest in other funds, for example, fund-of-funds or multi-asset strategies. There will be specific rules that clarify when such products can themselves qualify for a given category, and how they should report when they hold categorised products but not insufficient amounts to qualify as categorised themselves.

In those cases, non-categorised funds will have to state what share of their investments is in categorised products and base this on the information disclosed by those products further down the investment chain.

Is the SFDR 2.0 an improvement?

In terms of costs, there will be some one-off work to reclassify funds and adjust documentation. Nevertheless, the Commission expects the recurring costs of SFDR 2.0 to be lower than the current regime, especially once you factor in the savings from dropping entity-level disclosures.

The Proposal also adds definitions for “sustainability-related” products and for categorised products that explicitly claim to achieve impact as part of their strategy. This matters for two reasons:

• First, it gives fund managers clearer parameters for which products may call themselves “sustainability-related” in a formal sense. Merely relying on Taxonomy alignment was not working in the way that the Commission had intended. Just going through that assessment has proven very costly and burdensome, plus it disregarded many sectors as well as social objectives.
• Second, it finally gives impact investing a proper place in the framework, rather than forcing it to squeeze into the currentArticle 9’s box, which is too rigid to accommodate impact investing strategies and frameworks.

There’s also a fairness angle. Under the current SFDR, products that really lean into sustainability often face the most complexity, without a clear reward in terms of market recognition. The new categories, with clearer criteria and exclusions, should improve that balance, frontrunners should not feel punished for doing more.

The Commission keeps the familiar numbering “Article 8” and “Article 9”, but redefines what they stand for in a more intuitive way.

One point that has caused confusion online is the status of website disclosures. Some commentators rushed to suggest they would disappear. However, from the text of the Proposal it can only be derived that website disclosures remain mandatory, but they will be redesigned to align with the new rules.

In practice, that means the content, format and focus of website information will be updated so that it reflects the new categories and product focus.

Could the SFDR 2.0 be a win for investors?

It is worth ending with an important reminder: what we are seeing now is the Level 1 regulation the high-level legal framework agreed between the EU institutions.

The reality of the SFDR 2.0 will ultimately depend on the Level 2 rules, the more detailed Delegated Regulations that spell out the technical requirements: what goes in the templates, how indicators are defined and calculated, how thresholds and exclusions are implemented.

If those technical rules are clear and genuinely allow investors to show and uphold their level of ESG ambition, the SFDR 2.0 could genuinely be a step forward: less duplication, less box-ticking, more meaningful information for investors. If they become too vague, we risk recreating the same problems in a new structure.

For now, the signs are cautiously positive. The Commission has clearly taken on board much of the feedback about the current SFDR: the duplication with company reporting, the confusing use of Articles 8 and 9 as de-facto labels and the sense among serious sustainability players that they were doing a lot of work for too little clarity.

The proposal does not read as an attempt to roll back sustainable finance. Instead, it reads as an attempt to make it work better. Whether that remains true through the political negotiations is an open question.It would be a pity if the reform dissolved into deregulation under pressure.

In general, investors who are voluntarily and seriously engaging in sustainability are not asking for the rules to disappear. They’re asking for one coherent, mandatory framework, rather than a patchwork of competing labels and private standards.

In that sense, there may be less appetite than usual for weakening the rules and more support for turning SFDR 2.0 into the stable, fair reference point it was born for.

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