Since its implementation in March 2021, the SFDR requires financial firms to disclose how they integrate sustainability risks and manage negative impacts. However, doubts have arisen about its effectiveness in combating greenwashing. A study launched in 2022 by the European Commissioner for Financial Services, Mairead McGuinness, sought input on the clarity of the regulation and its ability to promote genuine sustainability.

In a study conducted with Marina Emiris of the National Bank of Belgium and Joanna Harris of the Chicago Booth School of Business, finance professor at the University of Luxembourg François Koulischer assessed the initial impact of the SFDR by combining central bank data with figures from data provider Morningstar. "We looked at the first phase of the SFDR, which started in 2021," explains Koulischer. "Our sample extends to the third quarter of 2022, with new rules introduced in January 2023 that have made a number of changes."

Analysing fund classification and investor behaviour, the study found substantial fund flows into 'green' categories, sections 8 and 9, in contrast to section 6 funds, which make no sustainability claims. "These results suggest that investors have reacted positively to the SFDR's enhanced transparency requirements for green funds", he observes.

Investor behaviour and fund classification

The SFDR framework requires funds to report in one of three categories--section 6, 8 or 9--based on their sustainability criteria. The study showed that many funds that already had a sustainability rating were classified in sections 8 or 9, although some funds that did not have green credentials also used these classifications. This rise in green categories reflects investor enthusiasm, but does not always correspond to the sustainability of the underlying assets.

Koulischer notes that while green funds have attracted more capital, the classification has not always encouraged funds to align their strategies with sustainable practices. "Some funds are reducing their emissions after being reclassified in article 8, but other article 8 or 9 funds are not reducing their emissions any more than article 6 funds", he explains. The study points out that institutional investors are more receptive to article 8 and 9 classifications, as they benefit from greater security.

One of the main problems identified by Koulischer is the misinterpretation of the SFDR categories. The intention of the SFDR was not to define green investment products, but rather to establish disclosure criteria. Yet many market players regard articles 8 and 9 as green labels, confusing investors and leading to accusations of greenwashing. "There is a difference between a 'green fund' and an article 8 or 9 fund," says Koulischer. "An unintended consequence of the SFDR is that it has significantly changed the market for labels and categorisations, even though this was not the original objective."

While acknowledging the demand for categorisation, Koulischer stresses that SFDR's design needs to be refined. "If the market interprets it as categorisation, then we need to be serious about categorisation. To achieve this, we need to strike a balance between clarity and realistic standards, which is not easy given the complexity of the definitions of 'green' and 'sustainable'."

Timetable and potential future revisions

The SFDR regulation preceded the Corporate Sustainability Reporting Directive (CSRD), which requires companies to publish sustainability data, which has caused timing issues for implementation. Koulischer believes that it would have been more logical to start with the information provided by companies, followed by the requirements of financial intermediaries and investors.

For the future, the European Sustainable Investment Forum (Eurosif) has suggested refining the SFDR classifications, possibly by creating separate 'sustainable' and 'transition' categories (see below). The 'sustainable' category would limit its investments to assets that are currently green, while the 'transition' category would include assets that are currently brown but are on the road to sustainability. While Koulischer finds this approach promising, he warns that practical implementation could be fraught with pitfalls.

"How do you implement it? It will be very difficult... Take sustainable funds. You would ask them to adopt an exclusion strategy. But what would the criteria be? If, for example, we stipulate a maximum of 5% of turnover in controversial activities, such as armaments, doesn't that create an incentive for companies to disinvest slightly in order to stay just below the threshold, or to engage in set-ups?" he asks, stressing that "the devil is in the detail on this kind of issue".

The real risk, in his view, is that ESG rules will be circumvented, with companies exploiting the thresholds. "It is essential to move forward with the SFDR regulation, but the more precise we are, the more we open the door to this type of arbitrage", he warns.

50%

In their study on the impact of the SFDR on the European fund market, Emiris, Harris and Koulischer found that almost 50% of funds by assets initially chose to classify themselves as green funds (article 8 or 9) when the regulation was introduced. Over the following quarters, 'green' funds recorded positive inflows totalling 10% of their assets, compared with modest growth of 2% for brown funds (article 6).

Alfi: “Empowering investors”

The objectives of the SFDR are in line with the interests of stakeholders, but difficulties remain in its application. The comments received by the European Commission in 2024 highlighted the need for improvements, in particular the voluntary categorisation of products to promote transparency.

The CEO of the Luxembourg Association of Investment Funds, , stresses the need to support transition investments. "There are two main issues: firstly, an approach that enables transition, as many companies are still on the road to meeting all sustainability requirements." According to Weyland, capital markets should be used to support these transitions. However, he warns that the current framework lacks clear reporting and product labelling guidelines.

Another priority for Weyland is investor accountability. "It is essential to simplify things for investors, particularly small investors who are often confused by the ESG landscape," he notes. In fact, complexity affects even institutional investors, who struggle to accurately measure the impact of their investments.

The importance of optionality

One of the central themes in Alfi's view is the balance between investor protection and flexibility. Weyland believes that the guiding principle is to "empower investors". "We have overprotected investors in Europe, discouraging them from investing, including in ESG," he says. "Many clients reject ESG filters in Mifid questionnaires [on investment suitability] because they see them as restrictive."

Alfi argues for greater transparency and choice. "It's about optionality," concludes Weyland. "We need to give investors a clear and understandable view of ESG impacts while allowing them to choose freely. Simplifying regulation in a way that empowers investors is essential for the future."

This article was written for the  edition of  magazine, published on 11 December. The magazine content is produced exclusively for the magazine. It is published on the site to contribute to the full Paperjam archive.

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