EU Regulators Propose New Sustainability and Transition Categories for Financial Products

EU Regulators Propose New Sustainability and Transition Categories for Financial Products

The European Supervisory Authorities (ESAs) published a new assessment of the Sustainable Finance Disclosure Regulation (SFDR), proposing changes and updates to the regulation. 

These updates include the introduction of new Sustainable and Transition categories for financial products, such as investment funds, life insurance and pension products. The ESAs include The European Securities and Markets Authority (ESMA), The European Banking Authority (EBA), and The European Insurance and Occupational Pensions Authority (EIOPA).

The ESA’s new assessment follows the launch last year by the European Commission of a comprehensive review of the SFDR framework. The review’s objective is to establish harmonised rules for financial market participants including investors and advisers on transparency regarding the integration of sustainability risks and the consideration of adverse sustainability impacts in their processes, and the provision of sustainability‐related information with respect to financial products.

The regulation currently includes classification levels for sustainability-focused investment funds, each with varying disclosure requirements, including Article 8 funds that promote environmental or social characteristics or a combination of those characteristics, and the more stringent Article 9 funds which have sustainable investment as their objective. In its review, the Commission expressed concern that the Article 8 and 9 classifications were being used as de-facto sustainability quality labels, raising potential greenwashing risks.

New ESA Categories for Sustainable Financial Products
In the assessment, the ESA’s addressed the Commission’s Article 8 and 9 concerns. The ESAs stated that they are in favour of the introduction of regulatory product categories that would help address the greenwashing problems arising from the misuse of the disclosures under Articles 8 and 9 of the SFDR, and this aims to generate clarity for investors, in particular retail investors.

Despite SFDR being conceived by the co-legislators as a disclosure regulation, the two disclosure regimes set out in Article 8 and Article 9 of the SFDR have been used as sustainability labels by financial market participants and understood as labels by investors. This approach has undermined the intended goal of the disclosures and created confusion for investors. Among the key proposals included in the ESAs’ assessment, aimed at eliminating the risk of misuse of the SFDR and improving clarity for consumers, were the introduction of a categorisation system for financial products, as well as an indicator to better understand the sustainability profile of the products.

Based on clear criteria, the categories suggested by the ESAs included a Sustainable products category and a Transition product category. The Sustainable category would include products that invest in economic activities and assets that are already environmentally or socially sustainable, with products required to comply with minimum thresholds, such as minimum alignment with the EU Taxonomy for environmentally sustainable products. The Transition category would include products that invest in activities or assets that are not yet sustainable, but are aiming to become sustainable over time, with a pathway, considering both ambition and timeframe, compatible with EU and global environmental and social objectives.

ESAs' Proposal for Clearer Sustainability Labels and Indicators in Financial Markets
The proposed sustainability indicator would introduce a scale to grade financial products, aimed at simplifying complex sustainability information in an easily understandable format. The ESAs proposed options for the indicator, including introducing one indicator for products both within and outside the Sustainable and Transition categories, as well as one indicator for each category.

The ESAs’ assessment also includes disclosure and marketing proposals for financial products under the SFDR, including those that fall under the suggested product categories, those that have sustainability features but do not qualify for the categories, and for products that do not have sustainability features.

For products that have sustainability features, but do not qualify for the Sustainable or Transition categories, the ESAs propose requirements to disclose on the sustainability features in regulatory documents, as well as restrictions on the use of ESG or sustainability-related terms in product names and marketing. Products that do not contain sustainability features should not be allowed to use ESG or sustainability-related terms but should include a disclaimer making clear that they have no sustainability features and may be required to provide minimal disclosure on their negative impacts on sustainability.

Concluding remarks
The proposed reforms by the ESAs represent a significant step towards enhancing transparency and accountability in the financial markets regarding sustainability. By introducing clear categorisation and an indicator system, the ESAs aim to mitigate greenwashing risks and provide investors, particularly retail investors, with more reliable information. These measures not only align with the broader goals of the SFDR framework but also seek to harmonise sustainability disclosures across the EU, thereby fostering trust and promoting sustainable investment practices. As these proposals move forward, stakeholders will closely monitor their implementation and effectiveness in achieving these critical objectives.

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