How can we make the most of evolving regulatory standards on sustainability?

The European Parliament, elected by European citizens, creates laws for all twenty-seven member states. A wide array of regulations govern the market, like the European Market Infrastructure Regulation (EMIR) or the General Data Protection Regulation (GDPR) (EUR-Lex, 2016). Another major piece of legislation, one that is not yet formalized, is the Corporate Sustainability Due Diligence (CSDD) Directive, which is currently discussed amongst European lawmakers to ensure “companies identify, prevent, end or mitigate negative impacts of their operations on people and the environment” (Levin Sources, 2022). These regulations aim to make the market fairer, and more transparent. 

The Sustainable Finance Disclosure Regulations (SFDR) is one of the most important sustainability-related regulations created by the EU (EUR-Lex, 2019). The SFDR aims to provide transparency and create standards for disclosure by making financial market participants support their sustainability claims by disclosing and reporting on the integration of sustainability criteria into their products. This regulation is one of the main contributors to the EU’s overarching agenda to drive financial flows towards more sustainable outcomes. The SFDR came into force in 2021, and APG has already set its first steps with its implementation (APG, 2023). These regulations bring the opportunity for APG to adopt a leading role regarding sustainability. Do current regulatory shifts fuel APG's ambitions, or are they restricting the freedom and creativity of financial market participants?

The most important aspect of the new rules is that sustainable investments are classified according to three different colors: gray for investments without a sustainability scope (article 6 investments), light green for investments that promote sustainable or social goals (article 8 investments), and dark green for products with sustainable investment as their goal (article 9 investments) (Worldfavor, n.d.). In short, article 8 funds are those that work towards sustainability but are not made for the specific goal of a more sustainable world, whereas article 9 funds are set up with the explicit goal of working towards sustainability. 

Since its entry into force, SFDR has impacted financial market participants. For example, in the real estate industry, investors are less likely to invest in assets not covered by articles 8 or 9 of SFDR (van Alfen, 2023). The SFDR requires asset managers making sustainability claims on their products to publish a detailed impact report. Making investors formulate clear sustainability goals has the benefit that it can help combat greenwashing, which is one of the purposes of the SFDR (Hoekstra, 2023). Thus, investors claiming to offer sustainable investments in the EU are more likely to actually be sustainable. It also has the added benefit of making investors increasingly reflect about the non-financial impacts of their investments. 

In light of the growing societal demand for responsible investing, some financial market participants even leverage the performance of their products with regard to SFDR standards as a unique selling point. For instance, Triodos’s main webpage greets its visitors with “we offer article 9 funds and investment strategies” (Triodos, 2023). 

One final benefit of the SFDR is that it enables comparability between asset managers (BNP Paribas, 2021). Mirte Bronsdijk, Senior responsible investment manager at APG AM, explains that SFDR has become a yardstick to measure all green investments (APG, 2023). Similarly, the CEO of Robeco claims that SFDR will help separate the wheat from the chaff by reducing the conceptual ambiguity surrounding ESG (de Vos, 2023). The SFDR establishes sustainability disclosure and reporting standards, uncovering who is leading, and who is lagging behind.

However, the SFDR has not been received without objection. Some observers are already considering whether SFDR is ripe for an overhaul, claiming that investors are in need of a ‘time out’ (Schwartzkopff & Ainger, 2023). This backlash points to the lack of data available to organizations despite increasingly strict disclosure requirements. Due to this scarcity, over 175 billion Euros worth of investments potentially qualifying as article 9 were demoted to an article 8 designation.

Furthermore, an Article 8 classification does not necessarily entail that the corresponding product strongly considers responsible investing. For example, Morningstar research found that of the 20 largest article 8 funds, only one has the words responsible investing in its name (Kenway, 2022). This raises the question of how significant sustainability truly is to article 8 funds. Morningstar also reported that 700 funds switched their SFDR status in the second quarter of 2022, mostly from article 6 to the more ESG attractive middle category of article 8, while a quarter of these still appeared to lack the consideration of Environmental, Social, or Governmental (ESG) criteria (Andrew, 2022). 

Lastly, in the first six months of 2022, the involvement of article 8 and 9 funds in fossil fuels increased, meaning that the funds within these classes are not immediately decreasing their stake in fossils due to the new regulations (Kenway, 2022). The foremost reason for this is the oil and gas prices of the last year, increasing the share price and the portfolio exposure to fossil fuels. The fossil fuel companies that these funds invest in are, however, transitionary, meaning these companies made a commitment to move away from carbon emissions and set zero emission goals. Because of this, the merits of such investments are more nuanced than they may first appear. 

When the opportunities and the challenges of the SFDR are considered, financial market participants may ask themselves: How can we make the most of evolving regulatory standards on sustainability? Increasing societal demand for asset managers to invest (much) more responsibly is likely to result in further regulatory developments concerning sustainability. While these developments carry the implication of an ever-complexifying regulatory landscape, increasingly demanding standards represent an opportunity for financial market participants to embrace their role as potent drivers of change. How can we turn evolving sustainability standards into opportunities?