SFDR: Wait or anticipate?

After two years of application of the SFDR regulation by financial market participants (FMP), the market’s lively and diverse reactions have naturally led to a critical reassessment of the first version of the SFDR. In response to this feedback, a consultation was launched in December 2023, explicitly aimed at seeking the market’s opinion on a possible overhaul of the text of the law. This initiative reflects the regulator’s desire to bring greater clarity and rigor to the text, while seeking to bring the regulations more in line with other sustainability initiatives in the European Union and the UK. The FMP dilemma: Anticipation versus expectation. 

Against this backdrop of potential regulatory change, FMPs find themselves at a critical decision-making crossroads. With the June 30, 2024 deadline approaching for the second year of reporting under the SFDR, a predominant question emerges: should we wait for clarifications and amendments to the regulations, or anticipate the coming changes? This question is all the more pertinent given that, although the revised version of the SFDR will not be applicable for next June’s reporting, it will be in 18 months’ time for the third year of application. FMPs therefore face a major challenge–having to navigate between short-term compliance and long-term preparation for regulatory adjustments.

Under the current SFDR regulation, three fundamental criteria define a sustainable investment: firstly, it must make a positive contribution to an environmental or social objective; secondly, it must not cause significant harm to other environmental or social objectives, in line with the principle of doing no significant harm (DNSH); and thirdly, it must be made within a company that respects the principles of good governance. These three criteria, essential to the qualification of a sustainable investment, are likely to remain pillars in the revised version of the SFDR, which may emerge following the current consultation. However, a major change is expected in the way funds are categorized, moving from the current reporting obligations defined by Articles 6, 8, and 9 to new categories of financial products, named A, B, C, and D. A form of consensus has a already formed around categories A,B and D.

This evolution towards new categories will require financial players to assess positive contributions in greater detail. Specifically, category A will focus on specific solutions to identified sustainability issues, thus approaching impact investing. FMPs will be required to demonstrate that these positive contributions offer measurable solutions to sustainable issues affecting people and/or the planet. Consequently, it will be imperative to develop a strict methodological framework to meet these new requirements. Category B, on the other hand, groups together companies that operate in a more sustainable way than in the past, surpassing market practice. It will be crucial to explain in detail how these companies manage to improve their sustainability through the mitigation of their material negative impacts.

Our case study provides the keys to a clear, rigorous methodology for analyzing positive contributions through the concrete problems of an asset manager and two renowned companies such as L’Oréal and Vestas. 

It is a real guide for FMPs who want to avoid the pitfalls of greenwashing and thus comply efficiently with the SFDR while preparing its next version.