Recommendations for a new product labelling regime under the EU’s sustainable finance rules are aimed at enhancing clarity and effectiveness of sustainability disclosures for financial products. Sebastiaan Hooghiemstra at Loyens & Loeff reviews the opinion tabled by the EU’s supervisory agencies, and finds that the question on whether “Article 8” and “Article 9” products should be abolished, is not yet off the table.
On 18 June 2024, the European Supervisory Authorities, also known as the “ESAs”, published a joint opinion in which they expressed their recommendations for the next iteration of EU’s Sustainable Finance Disclosure Regulation, or SFDR, as Regulation (EU) 2019/2088, is known. The opinion comes at the own initiative of the ESAs and is to be read in the context of the SFDR wholesale consultation in which the European Commission sought feedback on a potential overhaul of the SFDR framework. This contribution discusses the most prominent topic of the opinion, namely the proposed “product labelling regime” for SFDR 2.0.
A system of product classification
Despite the SFDR being conceived by the co-legislators as a disclosure regulation, the two disclosure regimes set out in Article 8 and Article 9 of the SFDR have been, since the introduction of the SFDR, used as sustainability labels by financial market participants and understood as labels by investors.
This approach has undermined the intended goal of the disclosures and created confusion for investors. In line with the EC consultation that explored the development of an EU-level product classification system, ESAs in their opinion recommend two new product categories that consist of minimum criteria and not labels of excellence or so-called “best in class” products.
For products that invest in economic activities / assets that are already environmentally and/or socially sustainable, the ESAs recommend introducing a “sustainable product category”. Considering the difference in maturity between environmental and social topics, and in the absence of a social taxonomy, the EC could consider whether “sustainable products” should be (i) merged in a single category or (ii) split in two different categories, namely environmental and social.
The ESAs recommend a minimum “sustainability threshold” for “sustainability products” that, for environmentally sustainable products, would be based on investments in taxonomy-aligned economic activities. The part of the investment that is not taxonomy-aligned should at least respect the “do no significant harm” (DNSH) principle for environmental and social objectives and good governance requirements, provided those concepts are more precisely defined than what is currently in the SFDR.
For products that invest in economic activities / assets that are not yet sustainable, but which improve their sustainability over time to become environmentally or socially sustainable the ESAs recommend introducing a “transition product category”.
The ESAs suggest that the investment strategies of these products could be built on a mix of EU taxonomy KPIs to reflect the progressive improvement of environmental performance, transition plans disclosed by underlying assets and their analysis, product decarbonization trajectories, and mitigation of at product level (provided that specific and relevant indicators are designed and that a minimum level of mitigation is set out in the SFDR). Additionally, this product category could consider certain appropriate exclusions and criteria for a credible transition plan.
Disclosures and marketing
The ESAs propose specific disclosure and naming and marketing requirements that is based on the degree of “sustainability features” of the product. Products with sustainability features would be required to disclose those in pre-contractual disclosures, and those without would be required to have a prescribed disclaimer similar to the statement contained in Article 7 of Regulation (EU) 2020/852 , known as the “Taxonomy Regulation”.
The proposal of the ESAs can be summarized as follows:
Outlook: Towards a SFDR 2.0 “Product Labelling Regime”?
The recommendations expressed in the opinion are expected to have an impact on the future shaping of the SFDR 2.0 “product labelling regime”. The new SFDR product categories are inspired by those published by the French regulator last year (albeit with different product categories).
It is clear, however, that a product labelling regime is high on the agenda and that the debate with the question on whether “Article 8” and “Article 9” products should be abolished, is not yet from the table. With no set timeline for the EC to adopt SFDR 2.0., there remain many questions open in relation to the SFDR 2.0 “product labelling” topic.
Sebastiaan Hooghiemstra is a senior associate in the investment management practice group of Loyens & Loeff Luxembourg and Senior Fellow/Guest Lecturer of the International Center for Financial Law & Governance at the Erasmus University Rotterdam. The law firm is a knowledge partner of Investment Officer.