EU: SFDR 2.0 - the key milestones ahead

The European Commission's legislative overhaul proposal for the EU SFDR is a key regulatory development for asset owners and managers, and the process continues on its anticipated timeline. Important milestones in the coming weeks look set to provide some much-needed clarity on the direction of travel for market participants (for whom preparation for any changes to the existing regime is a priority). 

Next week, on 3^rd June, the European Parliament’s Economic and Monetary Affairs Committee (ECON) are set to discuss Rapporteur MEP Gerben-Jan Gerbrandy’s proposals (set out in his draft report dated 28 April) on the European Commission’s original position. The European Parliament will then vote on the proposals in a plenary session in Q3 (with the vote currently scheduled for 15 July) with a view to finalising its position in readiness for trilogues between the Parliament, Council and Commission to begin.

The Council of the EU is also in the process of developing its position, with the Cypriot Presidency of the Council having indicated that it aims to settle a common position by end‑June (before the presidency passes to Ireland). Trilogue negotiations will determine the final text – these are expected to commence in Q4, with agreement of the Level 1 text anticipated by the end of the year. 

What does the Parliamentary draft tell us so far about the direction of travel?

Whilst preserving the overall structure, in particular the Commission's three-category product framework (“Transition”, “ESG Basics” and “Sustainable”), the current Parliament draft makes proposals that look set to impose tighter criteria on asset managers than the baseline as originally drafted by the Commission. 

Key amendments proposed by the Parliament include the following:

• Introducing mandatory disclosure of a limited set of PAI indicators for products using one of the new categories to allow investors to compare products within each category, disclosure of other PAIs material to the investment, and voluntary disclosure of other PAIs (as opposed to a more flexible approach under the Commission’s original draft)

• Introducing mandatory disclosures, on a comply-or-explain basis, describing the engagement strategy pursued by the financial market participant and how it has been implemented in alignment with the objectives of the product (under the Commission’s draft, sustainability-related engagement strategies are listed as a qualifying investment approach only for Transition products). 

• Under the Commission’s original draft, whilst non-categorised products can refer to sustainability factors in pre-contractual disclosures, this must not be a central element (i.e. secondary to the presentation of the product characteristics in terms of breadth and positioning, neutral, and less than 10% of the presentation of the product’s investment strategy), and must not feature in in names, marketing communications or PRIIPs KIDs.  The Parliament draft paper agrees with this but takes it further, with the expectation that Funds that do not fit into any of the sustainable product categories would have to provide investors with a disclaimer that the portfolio “does not meet EU standards for defining sustainable financial products and protecting against greenwashing”. This is to make it clear to retail investors that they are not buying SFDR compliant products.

• The report proposes to further tighten the criteria under which products can classify themselves under the “ESG Basics” category.  Where a product seeks to achieve this classification by reference to: 

  • Sustainable investments with an ESG rating that outperforms average rating of the investment universe or the reference benchmark; or 

  • Sustainable investments that outperform the average investment universe or reference benchmark on a specific appropriate sustainability indicator, 

that outperformance is measured AFTER at least the bottom 20% of that investment universe has been eliminated.  The intention here is to create a more meaningful impact on sustainable investment

• The Commission proposals provided for funds where at least 15% of investments are in Taxonomy-aligned economic activities to be be deemed to meet the Article 7 (Transition) and Article 9 (Sustainable) investment requirements.  The draft Parliament report proposes that the safe harbour threshold should be increased from 15 to 20% (a condition, the rapporteur says, that is already met by 44.1% of current Article 9 funds).

• On burden relief, the rapporteur supports the Commission proposal on the removal of entity level PAI reporting – the rapporteur however advocates that those elements regarding burden relief should start applying immediately upon entry into force (as opposed to waiting until the rest of the regulation applies).

As noted above, we are still in the early stages of the passage of this legislation through the EU legislative process, and this is just the opening negotiating position for the European Parliament.  It remains to be seen what reaches, and survives, the trilogue process. 

In the meantime as discussions continue, firms will need to monitor the landscape closely to ensure readiness for the final position – at this stage the Level 1 categorisation framework is sufficiently developed to enable firms to commence their preparations e.g. mapping existing products against the proposed new categories, (albeit the technical detail will no doubt require further fleshing out as part of the Level 2 process). 

Get in touch if you’d like to discuss what the proposed SFDR 2.0 rules could mean for you.

You can find our earlier blog post on the Commission's proposal here