The Sustainable Finance Disclosure Regulation (SFDR) framework’s Article 6 has often been perceived as a dumping ground for non-sustainable investments. However, experts question whether this perception is accurate. Some argue that an Article 6 fund can sometimes be even greener than an Article 8 fund.
To address the concerns, the sector suggests revising the current classification system to impose a uniform obligation on all funds. From ‘grey’ to ‘green,’ funds would need to meet specific sustainability requirements and reporting obligations, with a focus on reducing the administrative burden for all.
Since March 2021, fund providers within the EU must transparently disclose their sustainability policies and associated risks. Funds with sustainable features or sustainable objectives fall under Article 8 and 9 of SFDR regulation respectively. If a prospectus does not mention sustainability, the investment automatically falls under Article 6 and doesn’t have to provide detailed sustainability information.
“In theory, that could indeed be the case,” said Klaske Beyer, consultant at advisory firm Charco & Dique, specialising in sustainability regulation. “The SFDR regulation requires market players to be transparent about what they do. A party could claim not to select based on sustainability, but it turns out the fund also contains green investments.”
‘Green bleaching’
Beyer identifies such a party may be accused of ‘green bleaching,’ the opposite of greenwashing. “In the case of green bleaching, you actually have a green product, but because you find it quite complicated to meet all the requirements and conditions, you (consciously) choose to market the fund as grey.”
Esma, the European Securities and Markets Authority, labelled green bleaching ‘problematic’ earlier this year, attributing it to ambiguity around certain rules.
The question then arises: what is actually meant by ‘sustainability’? “The European Commission wants financial market players to judge what is sustainable,” said Randy Pattiselanno, manager of Strategy & Regulatory Affairs at industry association Dufas, “but the market is left with many questions. What if 20% of a company’s activities are not sustainable, but the rest are? Is the company as a whole then sustainable?”
Pattiselanno sees both the market and legislators grappling with these questions. “The market is looking to the legislator or supervisor for answers and vice versa. At some point, there must be a breakthrough in this impasse.”
Wrong order
He believes it could still take years. “The regulation has actually been implemented in the wrong order. Asset managers must bare all to indicate what they do in terms of sustainability, while companies do not yet have to report extensively on their impact on the environment. As a fund manager, you have to drive on a highway that doesn’t actually exist yet.”
According to Pattiselanno, if you don’t want to be accused of greenwashing, data is essential. Still, companies are not yet publishing enough data. “We are only at the beginning of the journey here. This data will play a critical part in the debate about when an investment is truly sustainable. For us, it is now essential that companies do their best to report as much relevant data as possible, enabling asset managers to fulfil their SFDR obligations.”
Meanwhile, SFDR, according to the Dufas expert, does not take into account companies undergoing a transition to become more sustainable. Dennis Hänsel, Global Head of ESG Advisory at DWS, agrees. “The transition is hugely important, but it starts with brown companies. If a transition fund falls under Article 6, that fund should be able to move to Article 8 at some point, but when? More clarity is needed.”
“The classification based on SFDR becomes less relevant when you look at what exactly is in a fund,” said Pattiselanno. “Potentially, an Article 6 fund can be greener than an Article 8 fund. Investment choices by an asset manager for Article 6 products can unintentionally lead to a sustainable portfolio. Dissecting what’s in a fund is much more relevant for an investor than which category the fund falls into.”
Overhaul of entire classification system needed?
The question then is whether we should move away from the entire classification system. “There is some discussion about that. A large part of the market realizes that the SFDR needs to be revised,” said Pattiselanno. “There are quite a few parties, such as Triodos, who have already clearly stated that Article 6 should also comply with detailed SFDR disclosures.”
Hänsel hopes that the administrative hurdle to comply with Article 8 will be lowered, resulting in a broader spectrum of green funds. “There is now a situation where funds that make exclusions and have mentioned this in the prospectus fall under 8, while other funds that make the same exclusions, but do not mention it, automatically fall under 6. A nice starting point would be that all funds that make certain exclusions automatically fall under 8, regardless of whether they mention this in the prospectus.”
This would, according to Hänsel, result in the pool of Article 6 funds shrinking. “I see no further need for Article 6 if we can lower the administrative threshold for Article 8.”
This article originally appeared in Dutch on InvestmentOfficer.nl.