The European Union (EU) Council has reached an agreement on the negotiating position for the revised Sustainable Finance Disclosure Regulation (SFDR) rules, which are designed to simplify the ESG regulations, enhance transparency in sustainable finance and address greenwashing concerns with investment products. The reform will now progress to discussions with the European Parliament, and may redefine the EU market's classification and disclosure of sustainable investment funds.

The proposed framework aims to push for more transparent fund labelling and less confusion around ESG claims by investors. Within the existing SFDR framework, information that is meant to communicate the consideration of environmental, social and governance (ESG) issues in financial products has been described as investment labels, resulting in concerns that this information may be inconsistent and that the meaning of sustainability information is not always clear.

A new concept for sustainable finance categories has been proposed by the Council.The Council has been proposing a new sustainable finance categories.

The Council's proposed changes would introduce new SFDR product categories that would supersede the current SFDR product concepts, which are: “sustainable”, “transition” and “ESG basics”. The move is designed to establish a more organized framework for investors and financial institutions and simplify reporting for market participants.

A “sustainable” category would be for products that directly benefit the sustainable goals and a “transition” category would be for investment in companies to transition towards sustainable operations. The “ESG basics” category could be for products that take ESG factors into account, but don't meet the standards of the other two categories.

The new method is designed to eliminate vague sustainability labelling and give investors a more uniform set of information to evaluate financial products, said EU policymakers.

Emphasize transparency and investor confidence.

New disclosures for products in the sustainable and transition categories are added by the Council's position. Those financial market participants and institutions that would be subject to the reporting of principal adverse impacts would have to exercise at least three of the mandatory indicators from a list of indicators that has been drawn up by the European Commission.

The changes aim to provide greater consistency in sustainability reporting and enable investors to more effectively compare products according to their environmental and social performance. There are also expectations that regulators will have a better definition of how to track sustainability claims and be better equipped to deal with potential greenwashing issues.

The conditions for fossil fuel transition are included in the rules of Transition Finance.

The updated framework also includes investments related to companies that are active in the fossil fuel sectors. If certain conditions are met, under the proposed rules, such companies may be eligible for the transition category.

Companies would have to spend at least 20% of capital expenditures on projects that reflect the EU taxonomy, while having a clear and measurable trajectory for decreasing GHG emissions in a timely manner. The investments would also be subject to further disclosure obligations during the impact assessment process with respect to sustainability considerations.

Incorporating fossil fuel investments shows the continuing debate in the EU between climate transition targets and financing of emissions reductions in high impact industries.

PSIF is a limited liability company that manages public sector investments and professional funds.

The Council has also suggested that some general purpose issuances by public sector bodies within the EU would be able to fit the transition category. These investments are substantial in the portfolios of financial institutions, such as pension and insurance companies.

The proposal acknowledges the value of EU climate targets and sustainability goals as a framework to understand alignment of these investments with climate transition targets.

The Council also proposed cutting liabilities of alternative investment funds, which are only offered to professional investors. These funds would not be subject to the same categorisations as funds aimed at retail investors, where there is a lesser need for “standardised” sustainability information.

Next Steps in SFDR Reform Process

The Council's negotiating position is to start negotiating with the European Parliament once Parliament has taken its stance on a reform. The final result will impact the classification, communication and evaluation of sustainable investment products in the European financial market.

The revision of SFDR rules will also have implications for the future of sustainable finance in regulations outside of Europe: “Going beyond Europe, the revision of SFDR will continue to shape future approaches to sustainable finance regulation as global investors and regulators increasingly seek to enhance ESG transparency, and tackle misleading claims, while encouraging genuine climate transition investments.”