The European Union is taking a major step forward with its Green Deal initiative, and investors are now being encouraged to invest green faster. The Sustainable Finance Disclosure Regulation (SFDR) has been designed to play an important role in this effort by providing transparency into how investment firms and managers integrate sustainability risks into their decisions. But it is struggling in a confused industry.
With industry-wide working groups set up and consultants hired, the regulation seeks to define and classify investment products according to article 6 (not specifically sustainable), article 8 (sustainable features) or article 9 (sustainable objective). This legislation should help drive uniformity across the EU while encouraging more sustainable investments that align with the Green Deal’s goals.
SFDR is not a product label. It is transparency legislation designed by the European Commission for financial entities and products. How do investment firms and managers integrate sustainability risks into their investment decisions and how do they take into account the impact of their investment decisions on environmental and social factors? Questions that this regulation seeks to answer.
Before its introduction in 2021, industry-wide working groups have been set up and consultants hired to define and classify investment products: article 6 (not specifically sustainable), article 8 (sustainable features) and article 9 (sustainable objective). Just at the end of last year, a large number of products suddenly changed classification after regulatory clarification, and due to a growing recognition among the general public following publications such as “The great green investment investigation” by investigative journalists at Follow the Money and Investico.
Now comes the next step: from 1 January 2023, providers of sustainable funds are obliged to add a template with sustainability information to their prospectus. But in practice, SFDR documents on pension fund websites are broadly worded and often lack concrete information. One obstacle is that companies will not have to report sustainability data until the new Corporate Sustainability Reporting (CSRD) directive comes into force between 2025 and 2029.
Harmonisation
So what are the benefits of SFDR? Ernst de Klerk, partner at AF Advisors, when asked, sees them. “Marketing statements must now be in line with SFDR›s transparency documentation. Only, I find the templates complicated; pension fund participants or retail investors can hardly extract any information from them. But if marketing information is brought in line with those templates, you will get somewhere. Especially if the regulator keeps a keen eye on it.”
Dutch supervisor AFM has announced that it will investigate the implementation of level 2 in the first quarter of 2023.
Supervisor Zoë du Chattel: “SFDR makes it for better estimation of what a product does in terms of sustainability. That categorisation into 6, 8 or 9 does not help so much, but the underlying information that is made mandatory in a standardised way does. This makes products more comparable among themselves and it will soon be possible to see how they actually perform, because you also have to show periodically what has been achieved.”
“SFDR offers more transparency, technically and aims to harmonise information. But harmonisation does not automatically promote comparability,” said Daan Spaargaren, senior strategist responsible investment at pension fund PME. “Our participants will not get a better picture from SFDR of how we deal with sustainability, the elaboration is too complex for that.”
Raoul Köhler, Du Chattel’s colleague and sustainable finance coordinator at the AFM, countered. “You want people to gain insight, so we say: make it understandable for clients and make sure your communication is in line with that SFDR reporting.”
Lack of data
A common objection to SFDR is the lack of sustainability data at investee companies. «Yes, it is difficult to determine without data whether your investment is sustainable. But SFDR does not force anyone to invest sustainably,” said Du Chattel. “Only: if you claim that you do offer a sustainable product, you must be able to demonstrate how you do so. The lack of obligation for investors has disappeared.”
De Klerk: “I actually think it is a missed opportunity that the classifications do not offer investors more guidance.”
“What constitutes a sustainable investment is up to you with minimal guidance. I see gigantic differences in that. There are parties who consider 3 per cent of the MSCI World a sustainable investment, but there are also those who call 65 per cent sustainable.”
Sara Heinsbroek, sustainability & responsible investment project manager at VBDO, the Association of Investors for Sustainable Development, finds it striking that sustainable parties at SFDR do most of the work. “Actually, the effort should lie with ‘grey’ investors. As VBDO, we are very much in favour of transparency, but what you have to deliver now takes a lot of effort and cannot be offered like this to pension members or retail investors,” she said, adding , on a positive note, that she believes there is now a brake on making unfounded claims.
Spaargaren: “The guidelines on exactly how we should report are an obstacle, for example on the effects of sustainability on returns. It is strange that it is up to the «greens› to answer, while the grey part of the market does not have to.”
«I can imagine that frustration in itself, but it has been a political choice at the SFDR to say: if you claim something, prove it. As AFM, we have no influence on that,” said Köhler.
Money for greening
Will there actually be a greater institutional money flow towards sustainable initiatives soon because of this legislation? Köhler: “It is too early to pass judgement on how SFDR will work. Initially, the outlines were very broad. But now in phase two, information has to be delivered in a very targeted way.”
De Klerk is moderately optimistic: “Especially the institutional world would theoretically be helped by SFDR if the templates were used properly, but their working methods have not yet adapted to all the extra information that is now available.”
At Pension Fund PME, they argue that there is great willingness to comply with the letter and spirit of SFDR, but that more clarification and clarity is needed from the regulator.
Spaargaren: “Looking at the objective of the Green Deal, I wonder to what extent SFDR contributes to that as a transparency guideline. At the moment, SFDR does not directly encourage pension funds to invest more sustainably. It would be nice, though, if it counteracts greenwashing among product providers and external managers, and creates a more level playing field. At the same time, I do not advocate a lot of prescription.
That affects our independence to shape our investment policy in line with our identity.”
Heinsbroek: “Awareness is increasing, which is good for the sector. But our supporters report a lot of ambiguity about SFDR and that it costs a lot of time and money. It is also unfortunate that the ‘category 6, 8 or 9’ has come to dominate. Ultimately, it is about a sustainable financial market and a sustainable world. We should not lose that focus.”
This article originally appeared in Dutch in IO’s Institutional Investor magazine and on InvestmentOffier.nl.