As part of its review of the Sustainable Finance Disclosure Regulation (SFDR), the Autorité des Marchés Financiers (AMF) has recommended that the European Commission should establish rules aligned with the EU taxonomy, such as divestments from fossil fuels.
Concerns over the efficacy of the SFDR have rippled through Europe. At present, the main concern is over asset managers using the SFDR as a marketing ploy to prove that their funds are sustainable.
Last week, the European Securities and Markets Authority (ESMA) also expressed its apprehensions over greenwashing. In particular, it emphasised how fund managers could use articles 8 and 9 of the SFDR as a proxy labeling mechanism.
Morningstar data showed that by the end of 2022, more than half of UCITS fund assets were disclosing under article 8 and 9.
“The SFDR was designed not as a “product” regulation (like the UCITS directives) nor as a labeling mechanism, but merely as a disclosure regulation requiring financial market participants to disclose their extra-financial strategies and practices in order to reduce the risk of greenwashing,” said Brice Henry, a partner at Allen & Overy Paris. “However, article 8 and article 9 categories have been indeed viewed by the investors, in practice, as a kind of label or product category.”
It is important to note that the AMF does not condemn the use of the SFDR as a labeling tool. Rather its focus is to guarantee investors that they are financing a more sustainable economy.
“The idea is really to make some incremental progress, rather than a complete overhaul of the framework,” said Philippe Sourlas, managing director, asset management directorate at the AMF. “In particular, we would like to try to suggest a quick revision of SFDR. We want to achieve something that's manageable in the short term which means we have to build on the existing frameworks such as the EU Taxonomy.”
See also: Concerns continue to loom over SFDR
Objective and measurable criteria
The regulator has recalled that the SFDR is not prescriptive when it comes to the definition of sustainable investment and that it provides for a general definition, said Henry.
“Each financial market participant establishes its own definition based on this definition. This brings a certain flexibility to the financial market participants but harms the comparability of the products for the investors.”
Currently, discretion is largely left to asset managers to define which fund should be eligible for which fund category. This could lead to misunderstandings or misconceptions that may be misleading for the potential investors and clients.
“We feel it would be helpful to introduce a more objective and measurable criteria to classify the different categories, so as to avoid the difficulties,” said Sourlas.
See also: Greenwashing accusations may lead to ‘greenbleaching’
Recommendations
In the review, the regulator has stated that articles 8 and 9 inhibit investors attempting to evaluate or compare the level of financial product sustainability.
As a result, the AMF has recommended accounting for the existing rules by replacing the definition of sustainable investment with an "objectivised" definition (in reference to). It has recognised that the definition of ‘sustainable investment’ under article 2(17) is ambiguous and could lead to misinterpretations.
Consequently, the AMF has proposed aligning with existing mechanisms such as the EU Taxonomy, or even by integrating transition assets.
“A simpler route could be to include transition assets in the notion of sustainable investment, in order to allow financial market participants flexibility in the ESG strategies they wish to adopt,” said Henry. “On the other hand, a clear definition of a "transition asset" would be welcome to ensure legal certainty for financial market participants and readability for investors.” .
Other proposals include setting a minimum standard for articles 8 and 9 financial products. Compliance with these additional requirements should be carried out at a national level. The review also states article 9 financial products should continue to be more prescriptive than ones under article 8.
“The AMF recognises - as a consumer protection agency - that these classifications do not protect consumers insofar as many consumers would assume that sustainable funds do not contain very high carbon companies and contain truly "green" companies primarily, rather than the "ESG tilting" that too often is what happens in practice,” said Jakob Thomae, managing director at the 2° Investing Initiative and senior fellow at the SOAS Centre for Sustainable Finance.
He continued: “I am not sure this would reduce "confusion" but will likely bring the labels more in line with consumer expectations.”
The AMF has also recommended a minimum percent of alignment with the EU Taxonomy for article 9 funds.
This will include an incremental rise in percentage depending on the European economy over time and a grandfathering clause for close-ended funds.
“Sustainability objectives differ dramatically across retail customers and regulatory categories will struggle to reflect this no matter how sophisticated and advanced,” said Thomae. “One key element of the proposal is that it reflects a core expectation that companies must become better, they must transition.”
See also: Funds question logic behind SFDR
Future actions
The AMF has acknowledged that the aim of the proposals is to shed light on the gaps within the SFDR in light of the Commission’s review of the SFDR.
These proposals will likely benefit market participants as asset managers will be forced to reevaluate categorisation of their funds under article 8 and 9. but also more generally, how they perceive the requirements of sustainable products.
“Investors can build any fund they want in principle, it just depends what consumers are willing to invest in and at what cost,” said Thomae. “This isn't a technical challenge, but of course this may simply reduce the number of classified funds. This may not be a bad thing though at the end of the day, separating the wheat from the shaft.”
