Brussels is cranking back to life this week, and the Sustainable Finance Disclosure Regulation (SFDR) will be one of the first files up for debate.
The Council of the European Union agreed its negotiating position before the summer break, but Elise Attal says that Ireland – which is running the Council until the end of 2026 – wants co-legislators to enter negotiations as soon as possible.
“The Irish presidency is very keen to mark SFDR as completed under their presidency, so there’s an incentive to start trialogues quite fast, and to wrap them up before the end of the year,” explains the head of European policy at the Principles for Responsible Investment (PRI).
It is a timeline Attal describes as “ambitious”, given that ECON, the parliamentary committee in charge of the file, failed to agree its negotiating position in July, as planned.
Its members will therefore reconvene for a vote this month. At the time of writing, a date has not been officially announced, but those close to the discussions expect it to be at a scheduled ECON meeting on 10 September.
After that, it is typical for all members of the European Parliament to vote on the committee’s decision during the subsequent plenary session, but this step can be bypassed in certain instances, which could speed up the negotiation process.
The key battlegrounds
When trialogues do start, it seems likely that only a handful of issues will prove contentious.
The Transition Category (Article 7) will be the most controversial aspect of the SFDR discussions.
Updated rules around Principle Adverse Impacts (PAI), now referred to as “sustainability-related indicators”, are another source of debate.
Under the European Commission’s legislative proposal, funds seeking to use the Sustainable (Article 9) and Transition labels would have to report on sustainability-related indicators – the text doesn’t specify which ones, but a list of options would be developed at Level 2 – and explain any attempts made to mitigate them.
“The Council’s position is more restrictive, suggesting that Transition and Sustainable products use at least three indicators from the Level 2 list,” says Heike Schmitz, a partner specialising in ESG at law firm HSF Kramer.
Meanwhile, it looks like Parliament will push for the new PAI concept to be mandatory for all three product categories, including ESG Basics (Article 8), prescribing that all funds must report on emissions and fossil-fuel exposure.
Transition and Sustainable funds would have to adopt an additional indicator from the Level 2 list, based on what’s most relevant to their claims.
The other big battleground in negotiations will be sovereign bonds: the Commission doesn’t want any general-purpose public-sector bonds to be counted as contributing to sustainability or the transition, because there aren’t yet credible methodologies to evaluate those claims.
Given their high exposure to government debt, such an exclusion would make it difficult for pension funds to qualify as Transition or Sustainable – they’d need at least 70% of their assets to be eligible.
The Council will push for a more flexible approach, in which bonds issued by EU member states or EU-level public bodies can be included if they meet certain criteria and don’t represent more than 15% of the overall portfolio.
Carve outs for certain products
The upcoming negotiations will also include a debate about whether financial products that don’t market to retail clients should be covered.
“The Council wants professional investor-only funds to be allowed to opt out of SFDR 2.0,” explains Schmitz. “So you’d still be allowed to say whatever you want on sustainability, even if you’re not a classified product.”
The addition of the carve-out was a “bit of a surprise”, she says, because it hadn’t featured in any of the Council’s draft positions that had been circulating before the final position was published.
“But it seems that the more conservative representatives in the Council had shown a lot of understanding towards the investment industry on this issue.”
Attal says the PRI would rather not see exemptions in the final SFDR regime, “so that we can have comparability and a level playing field for everyone”.
What does it mean for pension funds?
Andrew Lilley, head of sustainable investment for Continental Europe at Mercer, thinks asset owners that don’t market their products should also be subject to certain carve-outs.
While some experts expect most pension funds to simply opt for the proposed regime’s ESG Basics category, which will be relatively easy to qualify for, Lilley points out that complying with the reporting duties alone requires a lot of resources.
To avoid putting smaller schemes off, EU lawmakers should consider a proportional framework, with more or less onerous requirements depending on asset size.
“There could be looser exclusion rules to account for pension funds’ universal ownership role,” he adds, and “greater recognition of the role of stewardship”.
Lilley believes evidence of corporate engagement could be used instead of insisting on blanket exclusions, or as a way to help meet the 70% threshold for assets that contribute to sustainability or the transition.
While there’s currently no sign that this level of asset-owner flexibility will make it into SFDR 2.0, Mercer is “still trying to build coalitions to advocate for these changes”, he says.
“The legislators we’ve spoken to do recognise the challenges facing asset owners and have shown willingness to engage, but the changes we’ve seen so far do not, in our view, go far enough.”
