SFDR 2.0: Europe’s fund labelling reform has transition blind spots that need fixing
With the EU planning to overhaul its fund labelling regime, stakeholders warn that it will need to tread carefully between incentivising ambition and addressing greenwashing
When the European Commission first proposed a revision of its fund labelling regime, preventing greenwashing was amongst its most pressing concerns. Its proposal for a revamped Sustainable Finance Disclosure Regulation (SFDR) was published over four months ago.
As stakeholders digest the details, concerns are being raised about the new regime’s effect and the blind spots that linger in its design.
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Striking a balance
Among the key changes proposed, is the introduction of three fund labels – sustainable, transition and ESG basics. The European Sustainable Investment Forum (Eurosif), a network of European investor groups – has welcomed the shift to product categories.
The reform, the group reckons, is in the interests of European asset owners. There are, however, changes it says are needed to make SFDR fit-for-purpose.
“The European Commission proposal contains some positive steps forward. However, it falls short of establishing sufficiently robust criteria and meaningful disclosures needed to meet end investors’ expectation”, Eurosif executive director Aleksandra Palinska said in her initial response.
In a new position paper published this week, Eurosif has put forward its full set of recommendations. The key message from the investor network is that SFDR’s success will depend on finding a balance between incentivising ambition and addressing greenwashing.
Financing reduced emissions
The SFDR’s new ‘transition’ category is where this balance is hardest to strike. The EC’s proposal is to steer capital held in these funds towards companies with credible transition strategies. Crucially, the proposal falls short of defining the credibility of such plans.
Eurosif says clear definitions around credibility and strengthening guardrails around transition funds is necessary.
For instance, the group recommends transition fund labels to require a minimum percentage of investments with credible asset-level transition plans. In addition, Eurosif has recommended making credible engagement a core requirement of transition fund labels, rather than an add-on.
While welcoming exclusions on fossil fuel expansion, the group argues exclusions must not come at the cost of reducing financing available for companies with fossil fuel legacies looking to transition.
For instance, the exclusion of companies deriving more than 1% of revenue from hard coal and lignite Eurosif views as counterproductive.
“This approach would exclude companies with credible transition commitments but with existing coal activities from “transition” products, which is often the case, particularly in some countries that remain dependent on fossil fuels. Yet these companies are precisely the ones that need financing to support their transition”, the group says.
The way things stand, estimates suggest SFDR 2.0 transition fund labels could lead to €2.3bn of fossil fuel investments being inconsistent with the new rules. That is according to research conducted by advocacy groups Urgewald, Finanzwende and Facing Finance.
Blind spot
The advocacy groups have warned that the third label – ESG basics – runs a higher risk of greenwashing.
“The revision of the SFDR could be a milestone for credible sustainable financial products. For this to succeed, however, the blind spot that the ‘ESG basics’ category represents needs fixing”, says Fiona Hauke, a financial regulation expert at Urgewald.
“The term ‘ESG’ clearly conveys a sustainability claim to consumers. The mandatory exclusion of fossil fuel expansion must also apply to the ESG basics category”, she adds.
Eurosif, which has welcomed the third label, has also called for additional clarifications. An ESG basics label, the group recommends, must be accompanied by ‘tailored’ naming and marketing rules.
“The criteria for the ESG basics category should not result in this category becoming all encompassing”, the group warns. The unintended ‘all encompassing’ issue, Eurosif says, is a lesson to be learned from Article 8 funds under the current framework.
The success of Europe’s fund labelling reform will hinge on balancing credibility against ambition. Eurosif and the advocacy group positions identify key tenets of that balance – including making space for transition capital to flow where it is needed whilst tightening guardrails and raising the bar on eligibility criteria.
