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Addressing the Flaws of the Sustainable Finance Disclosure Regulation: Moving from Disclosures to Labelling and Sustainability Due Diligence

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Abstract

The EU Sustainable Finance Disclosure Regulation (SFDR) establishes disclosure requirements to tackle greenwashing and ensure transparency for financial products. Contextualising the assessment based on literature on disclosures and indicators in the field of sustainability, as well as sustainability due diligence, this article analyses the SFDR disclosure requirements and its key definitions. It shows that the SFDR does not require that financial market participants (FMPs) cease or remedy the principal adverse impacts connected to their investments. The definitions of ‘promoting environmental and social characteristics’, ‘sustainable investment’ and its requirement of ‘do no significant harm’ are extremely open-ended and have not prevented FMPs from including investments harmful to sustainability, such as in oil and coal. The disclosure of complex ‘proxies’ for sustainable performance, such as investment policies and strategies, as well as a limited use of benchmarked information about positive and adverse sustainability impact cast doubt on the extent to which disclosed information can be understood and effectively drive investors towards sustainable investment products. Enabled by these shortcomings, FMPs have started using the SFDR as a label to claim that their products are ‘sustainable’. This article illustrates how the SFDR could be amended to introduce elements that would better align it with the practice of sustainability due diligence under the future Corporate Sustainability Due Diligence Directive and bring it closer to a labelling regime signalling products with higher sustainability credentials ˗ while still offering investors necessary sustainability-related information about products and entities.

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Notes

  1. Regulation (EU) 2019/2088 of the European Parliament and of the Council on sustainability-related disclosures in the financial services sector, L 317 (SFDR).

  2. High-Level Expert Group on Sustainable Finance (2018).

  3. It applies, among others, to alternative investment fund managers, management companies of undertakings for collective investment in transferable securities, insurance undertakings, investment firms and credit institutions providing portfolio management.

  4. It covers, among others, portfolio management, investment advice, alternative investment funds, undertakings for collective investment in transferable securities and pension products.

  5. Commission Delegated Regulation (EU) 2022/1288 supplementing Regulation (EU) 2019/2088 of the European Parliament and of the Council with regard to regulatory technical standards specifying the details of the content and presentation of the information in relation to the principle of ‘do no significant harm’, specifying the content, methodologies and presentation of information in relation to sustainability indicators and adverse sustainability impacts, and the content and presentation of the information in relation to the promotion of environmental or social characteristics and sustainable investment objectives in pre-contractual documents, on websites and in periodic reports, L 196 (SFDR Delegated Regulation), Recital 17.

  6. While a uniform definition of greenwashing does not currently exist in EU law, the European Supervisory Authorities employed the following definition in a series of reports: ‘[A] practice where sustainability-related statements, declarations, actions, or communications do not clearly and fairly reflect the underlying sustainability profile of an entity, a financial product or financial services. This practice may be misleading to consumers, investors, or other market participants’, ESMA (2023) Progress Report on Greenwashing.

  7. Steuer and Tröger (2022), p 5.

  8. ESMA (2022a)

  9. Chiu (2022).

  10. Colaert (2022), p 1706.

  11. Teubner (1983).

  12. Bar-Gill and Board (2012), pp 240-241.

  13. For an assessment in several areas of law, see Ben-Shahar and Schneider (2011).

  14. Ibid.

  15. Sarfaty (2015), pp 117-118.

  16. Directive 2014/95/EU of the European Parliament and the Council of 22 October 2014 amending Directive 2013/34/EU as regards disclosure of non-financial and diversity information by certain large undertakings and groups, OJ L 182/13.

  17. Regulation (EU) 2017/821 of the European Parliament and the Council of 17 May 2017 laying down supply chain due diligence obligations for Union importers of tin, tantalum and tungsten, their ores, and gold originating from conflict-affected and high-risk areas, OJ L 130/1; Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, § 1502.

  18. Chilton and Sarfaty (2017), p 23.

  19. Ibid.

  20. Monciardini et al. (2021).

  21. Davies et al. (2012), p 6.

  22. Davies (2014), p 38.

  23. Engle Merry (2011), pp S90-S92.

  24. In the deforestation space, see Partiti (2022).

  25. Ben-Shahar and Schneider (2011), pp 743-744.

  26. Steuer and Tröger (2022), p 33.

  27. Bjørner et al. (2004).

  28. See https://fsc.org/en (accessed 21 March 2024).

  29. Regulation (EC) 66/2010 of the European Parliament and of the Council on the EU Ecolabel, OJ L 27.

  30. See https://www.nordic-swan-ecolabel.org/criteria/investment-funds-and-investment-products-101/ (accessed 21 March 2024).

  31. Steuer and Tröger (2022) .

  32. Dadush (2012), p 394.

  33. Hess (2019).

  34. For a comparison between the effect of the UK Bribery Act and the Modern Slavery Act, see LeBaron and Rühmkorf (2017).

  35. Mares (2010).

  36. Human Rights Council (2011).

  37. Ramasastry (2015).

  38. OECD (2011).

  39. International Finance Corporation (2012).

  40. Macchi (2021).

  41. Bueno and Bright (2020).

  42. Bright et al. (2020).

  43. Regulation (EU) 2023/1115 of the European Parliament and of the Council on the making available on the Union market and the export from the Union of certain commodities and products associated with deforestation and forest degradation and repealing Regulation (EU) No 995/2010, OJ L150.

  44. Proposal for a Directive of the European Parliament and of the Council on Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937, COM(2022) 71 final, 2022/0051 (COD).

  45. Ibid.

  46. Partiti (2021).

  47. Ruggie (2017).

  48. Proposal for a Directive of the European Parliament and of the Council on Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937, COM(2022) 71 final, 2022/0051(COD), Art. 3(g).

  49. The OECD issued detailed Guidance documents on responsible business conduct for institutional investors, for corporate lending and securities underwriting, and for project and asset finance.

  50. Netherlands National Contact Point (2013).

  51. Paris Agreement to the United Nations Framework Convention on Climate Change, Dec. 12, 2015, T.I.A.S. No. 16-1104, Art. 2(c).

  52. Ibid., Art. 9(3).

  53. European Commission (2019).

  54. High-Level Expert Group on Sustainable Finance (2018).

  55. European Commission (2018).

  56. Ibid., p 1.

  57. SFDR, Art. 2(24).

  58. Bismuth (2023).

  59. European Commission (2018), p 55.

  60. ECB (2020).

  61. Ibid., p 3.

  62. EBA (2021).

  63. Ibid., p 32.

  64. EBA (2020).

  65. Capital Requirements Regulation 575/2013, OJ 2013, L 176/1-337, Art. 501quater; Investment Firms Regulation 2019/2033, OJ 2019, L 314/1-63, Art. 34. See also EBA (2022).

  66. Commission Implementing Regulation (EU) 2022/2453 amending the implementing technical standards laid down in Implementing Regulation (EU) 2021/637 as regards the disclosure of environmental, social and governance risks, L 324.

  67. Commission Delegated Regulation (EU) 2021/1253 amending Delegated Regulation (EU) 2017/565 as regards the integration of sustainability factors, risks and preferences into certain organisational requirements and operating conditions for investment firms, L 277.

  68. Commission Delegated Directive (EU) 2021/1270 amending Directive 2010/43/EU as regards the sustainability risks and sustainability factors to be taken into account for Undertakings for Collective Investment in Transferable Securities (UCITS), L 277.

  69. Commission Delegated Regulation (EU) 2021/1255 amending Delegated Regulation (EU) No 231/2013 as regards the sustainability risks and sustainability factors to be taken into account by Alternative Investment Fund Managers, L 277/11.

  70. Commission Delegated Regulation (EU) 2021/1257 amending Delegated Regulations (EU) 2017/2358 and (EU) 2017/2359 as regards the integration of sustainability factors, risks and preferences into the product oversight and governance requirements for insurance undertakings and insurance distributors and into the rules on conduct of business and investment advice for insurance-based investment products, L 277/18.

  71. Commission Delegated Regulation (EU) 2021/1256 amending Delegated Regulation (EU) 2015/35 as regards the integration of sustainability risks in the governance of insurance and reinsurance undertakings, L 277/14.

  72. Regulation (EU) 2020/852 of the European Parliament and of the Council on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088, L 198 (EU Taxonomy Regulation).

  73. Ibid., Art. 9.

  74. Ibid., Art. 3.

  75. Ibid., Art. 18.

  76. Commission Delegated Regulation (EU) 2021/2178 supplementing Regulation (EU) 2020/852 of the European Parliament and of the Council by specifying the content and presentation of information to be disclosed by undertakings subject to Articles 19a or 29a of Directive 2013/34/EU concerning environmentally sustainable economic activities, and specifying the methodology to comply with that disclosure obligation, L 443.

  77. Commission Proposal for a Regulation on European Green Bonds, COM(2021) 391 final, 2021/0191(COD).

  78. Ibid., Art. 6.

  79. ICMA (2021).

  80. Regulation (EU) 2923/2631 of the European Parliament and the Council of 22 November 2023 on European Green Bonds and optional disclosures for bonds marketed as environmentally sustainable and for sustainability-linked bonds, L 1/68, Art. 9.

  81. Commission Draft Proposal establishing the EU Ecolabel criteria for retail financial products, in particular Annex I. https://susproc.jrc.ec.europa.eu/product-bureau/product-groups/432/documents (accessed 21 March 2024).

  82. Commission Draft Decision establishing the EU Ecolabel criteria for retail financial products, Annex - EU Ecolabel criteria for awarding the EU Ecolabel to retail financial products, Criterion 2. https://susproc.jrc.ec.europa.eu/product-bureau/product-groups/432/documents (accessed 21 March 2024).

  83. TRV Risk Analysis (2022).

  84. Regulation 2019/2089 of the European Parliament and of the Council amending Regulation (EU) 2016/1011 as regards EU Climate Transition Benchmarks, EU Paris-aligned Benchmarks and sustainability-related disclosures for benchmarks, L 317/17. See also Commission Delegated Regulation (EU) 2020/1818 supplementing Regulation (EU) 2016/1011 of the European Parliament and of the Council as regards minimum standards for EU Climate Transition Benchmarks and EU Paris-aligned Benchmarks, L 406/17.

  85. Directive (EU) 2022/2464 of the European Parliament and of the Council amending Regulation (EU) No 537/2014, Directive 2004/109/EC, Directive 2006/43/EC and Directive 2013/34/EU, as regards corporate sustainability reporting, L 322 (CSRD).

  86. SFDR, Recital 21.

  87. FCA (2022).

  88. Commission Delegated Regulation (EU) 2021/1253 amending Delegated Regulation (EU) 2017/565 as regards the integration of sustainability factors, risks and preferences into certain organisational requirements and operating conditions for investment firms, L 277, Art. 1.

  89. ESMA (2022b).

  90. SFDR, Art. 4.

  91. Ibid., Art. 2(22).

  92. EBA, EIOPA, ESMA (2022a), p 15.

  93. Ibid., p 17.

  94. EBA (2021), paras. 105-149.

  95. For extensive guidance on the PAI indicators, see EBA, EIOPA, ESMA (2022b); EBA, EIOPA, ESMA (2022a).

  96. SFDR Delegated Regulation, Art. 7.1.

  97. Ibid., Art. 8.

  98. Ibid., Art. 9.

  99. Ibid., Recital 4.

  100. ‘Social’ indicators also include employee, respect for human rights, anti-corruption and anti-bribery matters.

  101. Task Force on Climate Related Financial Disclosures (2017).

  102. This is because all mandatory and optional PAI indicators are among the disclosure requirements in the level 2 requirement of the European Sustainability Reporting Standards (ESRS). EFRAG (2022).

  103. SFDR Delegated Regulation, Art. 7.2.

  104. Ibid., Art. 6.2

  105. Although, de facto, an FMP publishing a PAI statement must then consider PAIs in at least one product.

  106. Questions related to Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability-related disclosures in the financial services sector (Sustainable Finance Disclosure Regulation 2019/2088), Ref. Ares(2021)4556843 - 14/07/2021.

  107. OECD (2011); Human Rights Council (2011). See, for discussion, Partiti (2021).

  108. Are end investors in the position to assess, for example, whether a certain amount (in tonnes) of ‘hazardous waste and radioactive waste generated by investee companies per million EUR invested, expressed as a weighted average’ (PAI 9) is acceptable?

  109. Questions related to Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability-related disclosures in the financial services sector (Sustainable Finance Disclosure Regulation 2019/2088), Ref. Ares(2021)4556843 - 14/07/2021, p 7.

  110. Good governance practices relate only to investee companies and do not apply to investments such as governmental bonds, ibid., p 8.

  111. Ibid.

  112. Ibid.

  113. SFDR Delegated Regulation, Recital 10.

  114. Recital 11 of the SFDR Delegated Regulation holds explicitly that non-binding criteria in the investment decision-making process and the selection of underlying assets are not part of the disclosures under Art. 8.

  115. Questions related to Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability-related disclosures in the financial services sector (Sustainable Finance Disclosure Regulation 2019/2088), Ref. Ares(2021)4556843 - 14/07/2021, p 8.

  116. SFDR Delegated Regulation, Recital 12.

  117. Ibid., Art. 26.

  118. The Commission Proposal for the SFDR only contemplated disclosure requirements for funds aiming at sustainable investment. European Commission, Proposal for a Regulation on disclosures relating to sustainable investments and sustainability risks, COM(2018) 354 final, 2018/0179(COD).

  119. SFDR Delegated Regulation, Recital 21.

  120. EBA, EIOPA, ESMA (2022a), p 17.

  121. 93% of Art. 8 funds, and 71% of Art. 9 funds report a 0% Taxonomy alignment, Morningstar (2023).

  122. Questions related to Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability-related disclosures in the financial services sector (Sustainable Finance Disclosure Regulation 2019/2088), Ref. Ares(2021)4556843 - 14/07/2021, p 5.

  123. SFDR Delegated Regulation, Recital 15.

  124. Ibid., Art. 61. Minimum social and environmental guidelines apply to those investments too in order to ensure compliance with DNSH.

  125. EBA, EIOPA, ESMA (2022a), p 24.

  126. SFDR Delegated Regulation, Annex III and Arts. 40 and 43.

  127. Which focus, respectively, on selecting only the best performing investments against certain ESG criteria (best-in-class), selecting only investments belonging to certain themes such as contribution to a specific Sustainable Development Goal (thematic investment), or selecting an investment on the basis of the positive impact it generates (impact). See Eurosif (2022), p 7.

  128. EBA, EIOPA, ESMA (2022b), p 3.

  129. EBA, EIOPA, ESMA (2022a), p 32.

  130. The ESAs clarified that the scope of Art. 9(3) covers all funds pursuing greenhouse gas emission reduction, and not just carbon. Ibid., p 18.

  131. Commission Delegated Regulation (EU) 2020/1818 supplementing Regulation (EU) 2016/1011 of the European Parliament and of the Council as regards minimum standards for EU Climate Transition Benchmarks and EU Paris-aligned Benchmarks, L 406/17.

  132. As the requirements in Paris-aligned and Climate Transition Benchmarks are quite strict, FMPs can arguably avoid 9(3) classification by choosing a sustainable investment objective different from CO2 emission reduction. CO2 emission reduction can still be used as possible indicator to measure the achievement of another sustainable investment objective.

  133. EBA, EIOPA, ESMA (2022a), p 17.

  134. Answers to questions on the interpretation of Regulation (EU) 2019/2088, submitted by the European Supervisory Authorities on 9 September 2022, q2.

  135. SFDR Delegated Regulation, Recital 17.

  136. Pollman (2022), p 35.

  137. SFDR Delegated Regulation, Recital 10 .

  138. Ibid., Recital 22.

  139. EBA, EIOPA, ESMA (2022b), para. 48.

  140. Ibid., paras. 48-49.

  141. ESMA, EBA, EIOPA (2021a).

  142. ESMA, EBA, EIOPA (2021b), p 8.

  143. EBA, EIOPA, ESMA (2022b), para. 47.

  144. For a classification of DNSH criteria, see Platform on Sustainable Finance (2022a).

  145. See, for example, a speech of Robert Ophèle, President of the French AMF: Ophèle (2022).

  146. MiFID, Art. 24(3).

  147. AFM (2023); ESMA (2023).

  148. See https://www.morningstar.com/en-uk/lp/sfdr-article8-article9 (accessed 21 March 2024).

  149. Ibid.

  150. Eurosif (2022), p 9.

  151. See https://www.groene.nl/artikel/wat-is-de-kleur-van-geld-groen (accessed 21 March 2024).

  152. Colaert (2022).

  153. Commission Delegated Directive (EU) 2021/1270 amending Directive 2010/43/EU as regards the sustainability risks and sustainability factors to be taken into account for Undertakings for Collective Investment in Transferable Securities (UCITS) L 277/141, Recital 6; Commission Delegated Regulation (EU) 2021/1255 amending Delegated Regulation (EU) No 231/2013 as regards the sustainability risks and sustainability factors to be taken into account by Alternative Investment Fund Managers L 277/11, Recital 4.

  154. See, for example, EFAMA’s (European Funds and Asset Manager Association) reply to the European Commission consultation for an initiative on sustainable corporate governance, https://www.efama.org/sites/default/files/files/EFAMA%20response%20to%20EC%20consultation%20on%20Sustainable%20Corporate%20Governance.pdf (accessed 21 March 2024).

  155. ESMA (2023).

  156. Global Impact Investing Network (2019).

  157. ESMA (2022c).

  158. EBA, EIOPA, ESMA (2022c).

  159. Platform on Sustainable Finance (2022b).

  160. See, for example, the European Banking Federation: https://www.ebf.eu/financing-growth/draft-report-on-taxonomy-extension-options-linked-to-environmental-objectives-ebf-response/.

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  1. Group Senior Legal Counsel for Sustainable Finance, Triodos Bank, Zeist, The Netherlands

    Enrico Partiti

  2. Extramural Fellow, Tilburg Law and Economics Center, Tilburg, The Netherlands

    Enrico Partiti

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Partiti, E. Addressing the Flaws of the Sustainable Finance Disclosure Regulation: Moving from Disclosures to Labelling and Sustainability Due Diligence. Eur Bus Org Law Rev (2024). https://doi.org/10.1007/s40804-024-00317-6

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