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The European Commission's ("Commission") has published a proposal to amend the Sustainable Finance Disclosure Regulation ("SFDR") including the introduction of new product categorisation regime to replace the disclosures-based framework introduced under the SFDR in March 2021. The review has been shaped by the EU's overarching simplification agenda and the underlying intention is to simplify the requirements while ensuring the investors can access comprehensible information on the sustainability of their investments.
Background to the Review
The Commission initiated a review of the SFDR in late 2022, with a consultation running from September to December 2023. The Commission has found that, while the objectives of the SFDR remain broadly supported, several aspects of the rules are considered complex and difficult to implement. There have been issues related to the misalignment between the concepts and definitions in the SFDR and other EU sustainable finance legislation, such as the Taxonomy Regulation, while financial market participants ("FMPs") have faced challenges accessing reliable and comprehensive ESG data. The objective of investor protection has not been sufficiently met, compounded by the misuse of Articles 8 and 9 SFDR as quasi-labels, which was not the original intention. The Commission's overarching simplification agenda also calls for simpler rules, lower administrative burden and better enforcement while continuing to pursue the goals set out in the European Green Deal.
The Proposals
There are two key elements to the Commission's proposals: (1) simplify and reduce the sustainability-related administrative and disclosure requirements of the framework for FMPs and to enhance the coherence of the framework; and (2) improve investors' ability to understand and compare sustainability-linked financial products. The Commission's amendments therefore aim to considerably simplify reporting requirements and to introduce a three-way categorisation of financial products with ESG features.
The amendments include:
- the deletion of disclosures regarding principal adverse impacts ("PAIs") at entity level to avoid a duplication of requirements imposed under the Corporate Sustainability Reporting Directive ("CSRD");
- significant reduction in product-level disclosures; and
- setting up three categories for "sustainable", "transition" and "other ESG" products.
The Definition of "Sustainable Investment"
The definition of "sustainable investment" set out in Article 2(17) has caused significant implementation challenges. The Commission notes that this has led to wide divergence in practical application. The Commission has proposed the deletion of this definition from the SFDR, with the underlying concepts instead being set out in a simplified form in specific investment requirements for the three product categories. The concepts of "contribution to an environmental or social objective", of "do no significant harm" ("DNSH") and of "good governance practices" should therefore continue to be reflected in the requirements under each category. The current requirement to consider PAI indicators on sustainability factors when assessing DNSH will be replaced by a requirement for FMPs to apply a common set of clear exclusions covering practices and sectors that are commonly agreed to be most harmful.
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