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SFDR consultation shows sizeable appetite for transition finance category

European Union flags fly outside the European Commission building in Brussel
Respondents overwhelmingly supported the proposal to create a category for “products with a transition focus aiming to bring measurable improvements to the sustainability profile of the assets they invest in”, such as investing in companies with plans to decarbonise (Photo by: Kenzo Tribouillard/AFP via Getty Images)

Incorporating transition finance in the EU Sustainable Finance Disclosure Regulation ‘should be a top priority’, say respondents

Respondents to the European Commission’s consultation on the Sustainable Finance Disclosure Regulation have called for the creation of a category specifically to address financial products with a transition focus.

The SFDR imposes disclosure requirements for EU market participants, with the aim of helping investors better understand the sustainability focus of financial products. Article 9 products invest specifically in sustainable assets, while products that promote environmental and social factors can take Article 8 status. Article 6 funds do not incorporate sustainability in their investment approaches.

In a consultation published on September 14 and which ran until December 22 2023, the commission proposed and sought views on building “a more precise EU-level product categorisation system based on precise criteria”.

A report summarising responses to the consultation published by the commission on May 3 says respondents showed no clear preference on whether to convert Article 8 and 9 classifications into “formal product categories by clarifying and adding criteria to support the already existing concepts”, or whether to base these categories on fresh criteria.

However, the proposal to create a category for “products with a transition focus aiming to bring measurable improvements to the sustainability profile of the assets they invest in” — such as investing in companies with plans to decarbonise — was overwhelmingly supported by respondents.

Eighty per cent said this category would be “useful to a large or very large extent”, while a significant per cent said incorporating transition finance in the SFDR “should be a top priority”.

There is “broad recognition that the SFDR should facilitate the flow of money into transitioning companies, which is not adequately covered by the current regime”, says Hortense Bioy, global director of sustainability research at data provider Morningstar.

“The creation of a specific category for products with a transition focus will be a welcome development,” she tells Sustainable Views. “It will provide a helpful framework for the industry to educate investors about the need to support companies in their transformation.”

‘The regime doesn’t work’

In contrast with the SFDR, the UK’s equivalent Sustainability Disclosure Requirements regime, which comes into effect at the end of May, contains a “sustainability improvers” label for products “that may not be sustainable now, but are on a path to improving their sustainability for the environment and/or society over time”, says the Financial Conduct Authority’s November 2023 policy statement.

Fifty-two per cent of respondents to the commission’s consultation did not agree that the SFDR “has successfully directed capital towards investments deemed sustainable, including transitional investments”, the commission’s report said.

“It looks like everyone agrees the regime doesn’t work, but no one can agree how to fix it,” says Lorraine Johnston, a partner at law firm Ashurst.

“The overwhelming support for a specific category of products with a transition focus is not surprising,” she tells Sustainable Views. “This is sorely lacking in the current SFDR framework and has caused fund managers difficulty where they want to launch funds with a transition strategy.” 

Metrics on transition

In a December 2023 paper setting out its thoughts on the consultation, asset manager Mirova called for the inclusion of “transition investment” to the SFDR, suggesting it could be defined in accordance with standards set by bodies such as the Science Based Targets initiative and the Transition Pathway Initiative. 

Mirova said that while Article 9 funds should remain mostly composed of sustainable investments, Article 8 funds “could allow a significant proportion of transition investments”. The concept of transition should consider “improved social impact” and also meet compulsory requirements based on “credible targets”, it said.

Asset managers and investment experts disagree over whether Article 9 funds should invest in transition finance.

James Hay, principal sustainability adviser at law firm Pinsent Masons, tells Sustainable Views that “integrating transition investments into SFDR opens up more possibilities as to how investors can potentially trade off conflicting sustainability objectives”.

“For instance, transition investments may permit asset managers to invest where there are social benefits to companies which do not necessarily meet the standard of sustainable investments,” he says.

Under SFDR, a sustainable investment is defined as investment in an activity that contributes to an environmental or social objective and does not significantly harm any environmental or social objective, with investee companies following good governance practices.

The majority of respondents to the commission’s report support the EU setting uniform disclosure rules for financial products offered across the bloc, regardless of their sustainability claims. “Many respondents also argued that metrics on transition should be added,” the report said.

A service from the Financial Times