Towards a review of SFDR

Back in 2018-2019, the European co-legislators and the European Commission designed the Sustainable finance disclosure regulation (SFDR) as a non-financial disclosure regime applying to financial entities and products. 

SFDR being intended as a disclosure regime, lawmakers have decided to refrain from offering a precise definition of concepts such as “sustainable investments”, “environmental/social characteristics” or the “consideration of principal adverse impacts”. That choice, which made sense in the context of a disclosure regime where the goal is to make sure that financial intermediaries and end investors find the information they need, implied that the interpretation of these concepts was left to the discretion of each financial market participant.

However, because SFDR has been used in practice as a labelling regime by market participants, this lack of clarity has confused investors even further. 

Thus, the AMF welcomes the Commission’s stated intention to undertake a review of SFDR and calls for a thorough recast of the Regulation. This paper provides a summary of the positions expressed by the AMF as part of its response to the SFDR targeted consultation of the European Commission.

In that context, the AMF’s main messages are the following.

1. The new framework should provide clarity in terms of product categorisation, and thus include product categories based on objective minimum criteria.
2. Conversely, the review should preserve a wide range for disclosures, seeking simplification wherever possible to focus on relevant disclosures for investors and taking into account other developments in the sustainable finance agenda.

An objective, clear and simple EU product categorisation system

As part of the broader European Union (EU) sustainable finance strategy, which intends to channel capital to sustainable activities and transition, the AMF advocates for an EU categorisation system to enable, above all, end investors to identify and compare financial products that make contributions to sustainability factors.

These new product categories should rely on minimum criteria to ensure that products belonging to them attain a minimum level of contribution. Rather than attempting to design labels of excellence for top-of-the-crop environmental, social and governance (ESG) financial products ⁽¹⁾, the establishment of an EU categorisation system should seek to create wide-ranging categories with criteria that act as entry points. Within such categories, financial market participants would be free to develop more ambitious strategies and practices, but because there may be multiple sustainable strategies that do not necessarily lend themselves to a simple ranking, there should be no hierarchy between categories.

All stakeholders, including financial market participants, distributors, end investors and national competent authorities (NCAs), should share a common understanding of what these categories are and require. To that end, the categorisation system should rely on objective minimum criteria that leave no room for interpretation.

Objective minimum criteria should echo existing regulatory tools (EU Taxonomy) and market practices (exclusions, non-financial screening) to limit the burden on manufacturers and distributors: the former would not need to develop internal methodologies from scratch, and the latter would have a robust common ground to understand and compare products.

Furthermore, compliance with the new categorisation system should be subject to national competent authorities (NCAs) supervision: a financial product claiming to belong to one category without meeting its minimum criteria should be considered in regulatory breach and be subject to NCAs enforcement action.

In the AMF’s view, a categorisation system that meets the aforementioned principles would have several benefits:

• the framework would remain flexible and compatible with existing national labelling schemes: as long as products comply with the minimum criteria of a category, their manufacturers could go further to differentiate their products from their peers’, for instance by obtaining a label or developing tailor-made approaches for sophisticated clients;
• the new categories could serve as a basis for developing rules on product denomination and promotional communication. For instance, only a product belonging to the “climate transition” category could use terms like “Paris-aligned” in its name and marketing material. Financial products that do not belong to a category could still make sustainability-related claims, but only in their regulatory documents and in a proportionate manner;
• categories should also be used in the context of the distribution of financial products to redefine the notion of sustainability preferences laid down in the Markets in financial instruments directive (MiFID) and Insurance distribution directive (IDD);
• with clear and robust categories, it could be argued that sustainability disclosures would not need to be as detailed and extensive, thus opening the way for some much needed simplification and alleviation of SFDR product disclosures.

On the basis of these principles, AMF proposes four categories: “environmental solutions”, “social solutions”, “climate transition” and “non-financial filters”⁽²⁾. Other categories may be introduced over time, for instance “biodiversity transition”. Those categories would make the current architecture based on Articles 9 and 8 of SFDR obsolete and replace it altogether.

Streamlined product disclosures

Manufacturers should disclose for all their financial products, subject to a ‘comply or explain’ approach, how they integrate sustainability risks in their investment decisions as well as an assessment of the likely impact of those risks on their products’ return. The existing Article 6 of SFDR could be redrafted to become more specific, primarily by spelling out the types of risks to be considered and the expected disclosures relating to the methodology used to quantify their impact on product return.

Additional disclosure requirements should apply to products with sustainability-related claims, i.e. products belonging to a category as well as uncategorised products making such claims in their regulatory documents. Those disclosures should aim to foster comparability between products while being understandable to retail investors. They could consist of a mandatory reporting on a limited set of indicators ⁽³⁾ and on the implementation of the financial market participant’s engagement and voting policies towards undertakings invested by the product. This could be complemented by voluntary disclosures on the decarbonisation targets of the product.

A refocusing of SFDR on product disclosures only

The sustainability information disclosed at product level represents the most useful information source for investors with sustainability preferences who search for a product to invest in. Therefore, it is doubtful that retail investors derive any substantial benefits from, let alone peruse, the sustainability information disclosed at entity-level. As regards sophisticated investors, they likely consider entity-level reporting as a “nice-to-have”, but continue to request specific and tailor-made information on a bilateral basis from product manufacturers or advisors.

Under the Corporate sustainability reporting directive (CSRD) framework, financial undertakings will be subject to sector-specific reporting standards. As those standards will reflect the double materiality approach, they will likely encompass disclosures similar to those which SFDR provides for at entity level. For the sake of clarifying the EU regulatory landscape, there would be merit in focusing SFDR on product-level disclosures, and remove all entity-level disclosures from the regulation, provided those disclosures are adequately dealt with under CSRD.

As only the largest financial market participants and financial advisors fall under the scope of CSRD, should it be deemed relevant that smaller actors disclose entity-level information, then the scope and provisions of CSRD should be amended accordingly.

Overview of the AMF proposal at product level: the global architecture.

Overview of the AMF proposal at product-level: suggested categories and thoughts about their minimum criteria.