Since the EU’s Sustainable Finance Disclosure Regulation (SFDR) came into force in March 2021, we have had some significant updates, including confirmation from the European Commission that Article 9 funds should only invest in sustainable assets and an amended Taxonomy that now includes natural gas and nuclear power, with the consequent changes to disclosure templates less than two months after coming in.
With a reported 40% of assets in Article 9 funds reclassified as Article 8 in the last quarter of 2022, following the Commission’s statement, there have been many requests for clarity over exactly what constitutes a sustainable investment, and the Commission has said it will publish the answers to over 200 frequently asked questions on the SFDR and Taxonomy regulations.
We now have what looks like a difference of opinion between two national regulators over the implementation of the SFDR. In February, the AMF in France published proposals for the SFDR to become a genuine classification regime, with a requirement for a binding ESG approach to be adopted by Article 8 and 9 funds and an almost total ban on Article 9 funds investing in fossil fuel companies.
That was followed within days, according to the Luxembourg Times, by the CSSF saying that these such decisions are not for individual regulators and these discussions should take place at a European level.
Meanwhile, in the UK, the FCA’s consultation on sustainable disclosure requirements and investment labelling closed at the end of January with slightly less wholehearted support than there appeared to be when CP22/20 was published last October.
Sustainability disclosures, fund classification and labelling, and corporate reporting of climate and ESG issues are complex subjects that only get more complex as you drill down into them, but a lack of clarity up front and a subsequent need for additional guidance do not help to achieve the stated goals of combatting perceived greenwashing and increasing consumer confidence in sustainable investment.
The “great reclassification” of Article 9 funds to Article 8 late last year was declared by some to be evidence of groups being caught greenwashing ahead of the application of the SFDR’s level 2 regulatory technical standards, while others described it as the industry responding to greater clarification from the authorities. Whichever it was, none of this helps the industry’s credibility in the eyes of the public, particularly when many of the funds concerned were Paris-aligned Benchmark or Climate Transition Benchmark ETFs, which had probably found their way into the portfolios of some of the more demanding sustainability investors.
It’s no wonder, as I wrote in an earlier article for ESG Clarity, so few advisers and wealth managers have any confidence in funds’ sustainability claims.
Unlike some other regulatory disclosure regimes, we can’t simply wait a few years until the regulators get everything right, as greater transparency around sustainable investment is essential. That is why the SFDR came into force almost two years before the regulatory technical standards were applied.
That said, we need enough clarity to avoid another “great reclassification” and we can’t have later waves of fund labels to remove confusion caused by the first wave. If over 200 questions are still being asked about the SFDR two years after it came into force, perhaps the regulation could have been clearer to start with.
Any change to disclosures made by funds is bound to lead to claims of greenwashing, even if nothing has changed from how the fund is currently promoted. But I am confident that groups want to comply.
Imagine, as will surely be the case for some funds currently called “ESG”, “sustainable” or “responsible”, that they fail to meet the FCA’s proposed hurdle for a “sustainable focus” fund in the UK of 70% of assets meeting “a credible standard of environmental and/or social sustainability”.
Or imagine a “responsible” or “sustainable” discretionary portfolio that doesn’t have at least 90% invested in funds with the same label, which would allow it to adopt that label.
Not only will they not qualify for the label, but they will be banned from using those (or similar) terms in their name or any marketing. Unless there is a change of heart before the FCA’s policy statement in a few months, there is no scope for discretionary managers to have a sustainable portfolio made up of funds with different labels.
The FCA will, quite rightly, be hoping funds step up to qualify for a label and continue using sustainability language, but that might not suit all groups. And while accusations of greenwashing make for good headlines, we should look at the reasons behind them before assuming it is the fault of the fund groups, as it may be due to a “clarification” by the regulator.