SFDR Classification: It's Still Shifting Times

• Jurisdiction: European Union
• Law Firm: TMF Group BV
• Subject Matter: Finance and Banking, Fund Management/ REITs, Fund Finance
• Author: Flavia Micilotta
• Published date: 28 March 2023

It's now close to two years since the Sustainable Finance Disclosure Regulation (SFDR) was implemented in the EU. The ESG-focused regulation tests the disclosure level of financial market participants, asking them to abide by transparency principles. The next phase kicked in this year and those affected need to be on the ball.

In January 2023, a series of technical standards pertaining to the SFDR directive's Level 2 disclosure requirements came into effect.

This constitutes an important moment in the application of this directive. After the first rollout phase, characterised by mainly high-level commitments to sustainability made by some participants in scope, this was the moment where a strong and clear commitment towards specific reporting rules on data was called for.

Analysts observed that this new phase determined an important shift in the number of funds, and therefore assets, that were initially deemed to be Article 9 - the highest standards of sustainable investments - or Article 8, also known as 'light green' products. In the latest Morningstar quarterly update on SFDR inflows and outflows, it was reported that in Q4 2022 assets in Article 8 and Article 9 funds rose by 7.3%, following substantial upgrades from Article 6 (funds not deemed to have sustainability characteristics) and denoting a drop in this category. By the end of January, the number of Article 8 funds had increased (starting in September 2022) to the detriment of Article 9 funds.

What does this tell us?

In essence, that the industry had an initial knee-jerk reaction to the higher impending disclosure requirements under Level 2, which determined a drop in the share of Article 9 products that shrunk by 40% in a three-month period. A decline in Article 9 products was felt from September. The past five months have witnessed a series of reclassifications with a total of 419 funds that have altered their SFDR status. Downgrades largely outweigh upgrades as looming disclosure requirements become increasingly clear. These 'shifts' follow to a large extent the SFDR legislative developments, as the Regulatory Technical Standards (RTS) become increasingly technical and demanding in terms of data. An important factor in these moves was also the significant hesitation as to the costs the Financial Market Participants (FMPs) would incur if caught not meeting the requirements for both international and national supervisors.

What are the main elements that drive these reclassifications?

Some...