New obligations for product disclosures under the Sustainable Finance Disclosure Regulation (SFDR) designed to iron out market concerns risk adding “confusion and complexity”, industry experts have warned.

Concerns over the current Articles 8 and 9 categories in SFDR have been growing in recent months with “vague” definitions of what constitutes an Article 8 fund leading many to believe the new rules could increase greenwashing practices.

Under current Article 8 requirements, funds must “promote” ESG characteristics, while to be defined as Article 9, asset managers must prove their fund has a sustainable investment objective.

In October, Sandro Pierri, CEO of BNP Paribas Asset Management, voiced his concerns on the regulations, stating different interpretations of the rules on sustainable investing across Europe are creating “confusion risk” for investors.

In a bid to alleviate these concerns, the European Securities and Markets Authority (ESMA) last month updated its requirements, creating two new product categories for funds that have an environmental objective.

Adrian Whelan, senior vice president at Brown Brothers Harriman, said: “It has been complex and confusing and these new versions of Articles 8 and 9 just add to the confusion and complexity. “I know they are trying to make it more prescriptive and to increase understanding, but in essence, they add to this fragmentation effect and so the disclosures become even more nuanced and subjective,” he added.

Cart before the horse

To meet the new requirements, firms will be required to include a “graphical representation” of their key performance indicators (KPI) as proposed in their pre-contractual disclosure documents.

In addition, “narrative disclosures” will also need to be produced including a breakdown of the environmental objectives. Funds that wish to be labelled Article 8 or 9 will be required to pursue one of six environmental objectives are defined by the European Union’s taxonomy, comprising climate change adaptation, mitigation, marine water resources, circular economy, pollution and biodiversity.

Gavin Haran, head of policy for asset management at Macfarlanes, said while these new categories – dubbed Article 8 and 9 ‘Plus’ – are more robust, the issue is that they will have to adhere to a very narrow set of requirements.

“What is not included is social objectives, so until there is a social taxonomy, it would not qualify for the plus category,” he said.

“The other surprising point is that you also have this principle of doing no significant harm to the other taxonomy objectives, which wasn’t the case in the draft.”

Additionally, Haran pointed out there is a delay between the publication of the rules for the new SFDR requirements and the taxonomy screening criteria. While the climate change rules look set to come in by the end of the year, the four remaining categories will likely take effect from January 2023.

Despite this, ‘level two’ of SFDR will be implemented in June 2022, meaning the requirements for the new categories will have the final rules of the taxonomy in place to follow.

“Although these rules have been put in place for the ‘plus’ categories, there is a lag until we have the details to allow you to work out where you fit in. It is a bit cart before the horse in some effects, unfortunately,” he said.

As a result, BBH’s Whelan stressed asset managers are currently “going with the wind” when it comes to SFDR requirements, adding right now it is more important to articulate their stance on ESG integration as opposed to implementing the 'nitty-gritty' of the regulation.

“Being able to interface and tell your ESG story for your investors is more important at this point in time than the detailed regulation,” he said. “If you cannot articulate your ESG story, that becomes your ESG story. It becomes a commercial disadvantage, and those that are well versed in articulating their ESG integration strategy are in a stronger commercial proposition.”

Backing up Whelan’s claims, Morningstar data found 56.8% of total flows were captured by Articles 8 and 9 funds over Q3, accounting for 37% of total assets under management. Furthermore, 50% of new fund launches in Europe were either Article 8 or 9 in the three months to September.

The gold standard

Concerns have also been raised on the issue of regulatory divergence across Europe when it comes to investing sustainability.

Whelan said the new proposals only add to this sense of fragmentation across the globe, and within Europe, as national regulators look to catch up with asset managers who have been investing in sustainability for several years.

He said: “Fragmentation across the ESGspace continues to increase, and that becomes an extra cost. At the moment, it is very hard to be a global manager housing funds in different regions, because direct fragmentation is very evident and obvious in the ESG space.”

Macfarlanes’ Haran added that despite SFDR’s increasing complexity the new requirements could, one day, become a gold standard for the industry. “It could help solve greenwashing if these ‘plus’ categories become a gold standard, but I cannot see that happening for two years until all of these things fall into place,” he said.

Whelan added: “If you can deal with the EU taxonomy and SFDR, you can deal with any subsequent subsidiary regulation, and that is a positive. Fragmentation is a challenge, but the silver lining is if you can deal with SFDR, you can deal with any of it.”

This article first appeared in ESG Unlocked: Sustainable Revolution In Full Swing, an ETF Stream report. To access the full issue, click here.

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