EIOPA and its fellow European supervisors have set out their stall as to the future of the European Union’s flagship sustainable finance disclosures regulation (SFDR), with suggestions for improvements including introducing an official product labelling system with a ‘transition’ category.

The European Supervisory Authorities (ESAs) also recommended introducing a way to grade financial products on sustainability and requiring disclosures for all products to reduce greenwashing.

Further suggestions include simplifying the way disclosures are presented to investors, prioritising only essential information for retail investors with more detailed information potentially to be provided for professional investors, and clarifying the concept of ‘sustainable investment’, which also appears in the EU Taxonomy regulation.

The ESAs also said information on key adverse impact indicators could be considered for all financial products, and that the European Commission may want to consider introducing a framework to assess the sustainability features of government bonds.

ESAs SFDR recommendations snapshot

Source: ESMA, EIOPA and the EBA

A graphic representation of the ESAs’ recommendations for a product classification system and indicators for grading

The SFDR entered into force in 2021 and was intended to increase transparency over how investors consider and manage sustainability-related matters. It has been beset by industry implementation problems and has, contrary to its design, been used as a de factor labelling regime. It has, however, also been found to have probably contributed to reducing greenwashing risks

More recently calls have grown for SFDR and the wider EU sustainable finance framework to do more to facilitate transition finance – investment strategies supporting assets that are not yet sustainable but on the right path.

The ESAs today also said the Commission should prioritise completing the EU taxonomy and extend it to social sustainability.

The Commission has acknowledged shortcomings of the SFDR framework and is weighing mixed market feedback on what it should do next, with an official proposal potentially due in the first quarter of 2025.

An overarching recommendation of “utmost importance” from the ESAs is that the Commission carry out consumer testing before putting forward any policy options “to have a stronger evidence basis for changing the regulatory framework and to therefore ensure more successful outcomes”.

The ESAs call for a coherent sustainable finance framework that caters for both the green transition and enhanced consumer protection, taking into account the lessons learned from the functioning of the SFDR

They said they were calling for “a coherent sustainable finance framework that caters for both the green transition and enhanced consumer protection, taking into account the lessons learned from the functioning of the SFDR”.

“The ESAs focus on ways to introduce simple and clear categories for financial products,” they added. “The simplifications consist of two voluntary product categories, ‘sustainable’ and ‘transition’, that financial market participants should use to ensure consumers understand the purpose of the products.

“The rules for the categories should have a clear objective and criteria to reduce greenwashing risks.”

Labelling system

According to the ESAs, the Commission should introduce a product classification system with at least two labels, for ‘sustainable’ financial products and ‘transition’ products. They said such categories would replace the current practice of categorisation in Article 8 and 9 of the SFDR.

For the ‘transition’ category the ESAs said the Commission should consider requiring “that an ambitious but realistic share of the product’s investments initially complies with the requirements of the transition product category and that such a share can subsequently increase over time”.

“This would make it possible to include some long-term products, in particular profit participation products and pension funds, that face restrictions or disincentives to change their asset allocation over time,” they said.

Government bonds

Another of the ESAs’ recommendations is for the Commission to consider developing a framework for assessing the sustainability of government bonds as without at least general criteria it would be difficult for pension schemes and other big heavy government bond investors to fully disclose on the sustainability features of their investments.

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