ESMA Recommends Overhaul of SFDR to Curb Greenwashing

The European Securities and Markets Authority (ESMA) has recently recommended a significant overhaul of the Sustainable Finance Disclosure Regulation (SFDR) within the EU. This recommendation aims to simplify and improve the clarity of sustainable investment regulations to address the prevalent issue of greenwashing in the sector. 

ESMA has proposed abolishing the current definition of ‘sustainable investment’ under the SFDR and suggested introducing a new two-tier system. This system would include a voluntary category aligned with the EU taxonomy for sustainable activities and a ‘transition’ category. The transition category would be assessed through key performance indicators that gauge progress in reducing sustainability impacts over time and apply a less stringent ‘do no significant harm’ (DNSH) criterion. 

Hortense Bioy, head of sustainable investing research at Morningstar Sustainalytics, highlighted that this new system would render the current SFDR Articles 8 and 9 redundant, potentially reshaping the EU market for sustainable investment funds. These changes aim to enhance market consolidation and gradually eliminate national labels prevalent in countries like France, Germany, and the Nordics. 

The reform suggestions include requiring all financial products to disclose sustainability information in line with an expanded EU taxonomy. This taxonomy would now encompass social and transitional activities, enhancing comparability across different financial products and reducing the scope for misleading information. 

Additionally, ESMA advocates for the European Commission to establish a clear legal definition for ‘transition’ investments, which would facilitate more reliable assessments of transition plan disclosures. The creation of ‘transition benchmarks’, tougher EU climate benchmarks, and standards for transition bonds and sustainability-linked bonds have also been proposed. 

On the data front, ESMA has called for the regulation of ESG data products, similar to the EU ESG Ratings regulation, to tackle issues related to data quality, consistency, and reliance on estimates. 

These recommendations come at a time when the EU Commission is reviewing potential improvements to the SFDR, following extensive criticism regarding its complexity. Recent data from Morningstar highlighted significant withdrawals from Article 9 funds, which target the highest level of sustainability ambition, while Article 8 funds attracted notable inflows, though still falling short compared to Article 6 funds, which lack a sustainability focus. 

The proposed overhaul by ESMA is expected to address the ongoing challenges in the ESG space, ensuring that sustainable investment regulations are clear, reliable, and effective in promoting genuine sustainability practices across the EU. 

Sources: 

https://fintech.global/2024/07/26/eu-regulator-suggests-revamp-in-sustainable-investment-rules/ 

https://www.reuters.com/sustainability/eu-regulators-propose-shake-up-sustainable-investment-labels-2024-06-18/