The Sustainable Finance Disclosure Regulation (SFDR) is a cornerstone of the European Union’s Action Plan on Sustainable Finance, aiming to promote sustainable investing and discourage greenwashing. New research evinces how crucial it is to establish transparent regulatory standards and strengthen information campaigns on sustainable financial products – for the benefit of investors. Despite its challenges, the SFDR enables investors to more easily identify investment products that align with their sustainable preferences.
It has been a year since the European Union (EU) began a sustainability revolution, setting in motion phase one of its Sustainable Finance Disclosure Regulation (SFDR). This measure requires financial market participants to classify their funds into one of three categories, Article 6, Article 8, or Article 9, based on the product’s sustainability objective. Since the introduction of SFDR, level 1, all funds managed by responsAbility fall under Article 9 of SFDR, which is also referred to as “dark green”. This makes them part of an exclusive few: Article 9 funds still account for a tiny 2.8 % of the overall EU fund universe, according to Morningstar, a research house.
Article 9 products focus exclusively on achieving a predefined sustainability objective. For these funds, sustainability is a mandatory element that steers the investment approach. In comparison, Article 8 designated funds are those promoting environmental and/or social characteristics among other characteristics (light green funds). Mette Emsholm Gahr, ESG Officer, at responsAbility, explains: “Article 9 funds must really target a sustainable investment objective, measured with specific sustainability indicators. In contrast, an investment product can qualify as Article 8 just by having an exclusion list in place, for example.” She adds that, “implementing an exclusion list can be achieved relatively easy.” In other words: Article 9 funds are substantially better from a sustainability perspective than Article 8 funds. The third SFDR category, Article 6 funds, integrate only sustainability risks into the investment process on a "comply or explain" basis. These traditional approaches, also referred as “non-sustainable funds”, capture approximately 60% of the combined assets under management of European Union domiciled funds, when excluding feeder funds, fund of funds, and money market funds.
“Article 9 funds must really target a sustainable investment objective, measured with specific sustainability indicators. In contrast, an investment product can qualify as Article 8 just by having an exclusion list in place, for example.” - Mette Emsholm Gahr, ESG Officer
The sustainable investment sector has seen a spectacular expansion in recent years. This in turn has given rise to concerns that asset managers may try to greenwash their product range to capture this demand. Switzerland’s case appears to be supporting this concern. According to Swiss Sustainable Finance, a trade body, assets managed by investment funds self-declared as “sustainable” have grown by a factor of four from 2017 to 2020, reaching a volume of CHF 1500 billion. As a pioneering impact investor, sustainability is deeply integrated into responsAbility’s DNA. In fact, responsAbility was founded in 2003 with the very mission to tackle the world’s most pressing problems while targeting healthy financial returns. responsAbility’s impact and ESG framework ensures that all investments contribute to a sustainable objective while avoiding to ‘Do No Significant Harm’ even before the introduction of SFDR.
As a result, responsAbility welcomes the introduction of the SFDR, despite its widespread challenges. With its reporting obligations, the SFDR substantially increases transparency within the sustainable financial sector, as it provides overarching requirements on what every financial market participant within the EU must disclose. This automatically leads to comparability between funds and enables investors to more easily identify investment products that align with their sustainable preferences. As Mette Emsholm Gahr explains:
“The introduction of product classification enables investors to actively steer their investments into sustainable funds contributing to specific sustainability goals. For article 9 funds, investors can be assured that a fund’s mission is to contribute to a sustainable objective, environmental and/or social, and will via annual reports be able to track the performance with sustainability indicators.”
The case of Switzerland, again, appears to validate the disciplinary effect the introduction of SFDR is exerting on market participants - to the benefit of investors. While there are not yet any official numbers regarding SFDR categorization, estimates strongly suggest that the combined assets under management of Swiss investment funds classified as either Article 8 or Article 9, or sustainable, are far below the CHF 1500 billion self-declared as “sustainable” prior to the implementation of SFDR. The need to establish transparent regulatory standards and strengthen information campaigns on sustainable financial products is also revealed by academic research. A recent study surveying Swiss private individuals finds that “Swiss households, which typically show high financial literacy by international standards, exhibit a low level of sustainable finance literacy.” The study is causing some stir in the world of investing. A leading Swiss newspaper covering the findings titled: "Easy prey for greenwashing: Most Swiss private investors are ESG illiterates.”
The first level of the EU Sustainable Finance Disclosure Regulation came into force on 10 March 2021, applying to the bulk of EU domiciled investment funds. It is a set of EU rules aiming to trigger changes in behavioral patterns in the financial sector, discourage greenwashing and promote sustainable investments. The level 2 of the SFDR, coming into force in January 2023, will further enhance the transparency around sustainability within the financial sector. The SFDR is a cornerstone of the European Union’s Action Plan on Sustainable Finance which aims to promote sustainable investment across the EU. All the new measures, including the EU taxonomy regulation, are in response to the Paris Agreement to become net-zero by 2050, and the United Nations 2030 Agenda for Sustainable Development, which created the Sustainable Development Goals (SDG).