Product classification system
The ESAs propose introducing a system of product classification to address greenwashing risks. This system would classify financial products based on specific criteria.
They recommend two main categories:
Sustainable product category:
- For products that invest in environmentally and/or socially sustainable economic activities or assets.
- The minimum “sustainability threshold” would be based on investments in taxonomy-aligned economic activities.
- Non-taxonomy-aligned investments should still adhere to environmental and social objectives and good governance principles.
Transition product category:
- For products that invest in activities/assets not yet sustainable but aim to improve over time.
- Strategies could include EU taxonomy Key Performance Indicators (“KPIs”), transition plans, product decarbonisation, and addressing principal adverse impacts (“PAIs”).
- Exclusions and criteria for credible transition plans may also apply.
These recommendations aim to enhance clarity for investors, especially retail investors, and contribute to the ongoing SFDR review by the European Commission. The timing and specifics of the review remain uncertain, pending the next Commission’s decisions.
Disclosures and marketing for products
The ESAs recommend disclosure, naming, and marketing standards based on whether a financial product meets the criteria for a specific category. For products that do not meet these criteria, the requirements vary further depending on whether the financial product includes sustainability features.
Categorised products are recommended to provide disclosures in regulatory documentation consistent with the category, as well as naming and marketing requirements consistent with the category.
Products that have sustainability characteristics but do not qualify for categories are recommended to provide limited disclosures in regulatory documentation on sustainability features, as well as restrictions on naming and marketing.
Products with no sustainability features are recommended to provide minimal disclosures on adverse impacts on sustainability factors, a clear disclaimer that products do not have sustainability characteristics, as well as restrictions on naming and marketing requirements.
Sustainability indicators
The next proposal is that all financial products should display a sustainability indicator using a scale, e.g., colour codes, ABCDE. This indicator would cover environmental sustainability, social sustainability, or both. This idea expands upon the European Commission’s 2023 consultation questions regarding the potential usefulness of sustainability scales in product-level disclosures. The primary focus is on clarity, as consumer testing and feedback from consumers reveal that they often struggle to understand the various sustainability objectives of financial products when reading SFDR disclosures, making it difficult for them to determine how sustainable these products are.
To be a reliable indicator for end investors, this system must be based on clear and objective criteria, ensuring each category is well-defined. This is a complex task that must be completed with careful consideration.
The ESAs also propose that these sustainability indicators could replace product categorisation within the SFDR framework or that the framework could integrate both product categories and a sustainability indicator. In this integrated approach, the sustainability indicator could either function separately within each category or operate independently of product categories.
Definition of “sustainable investment”
The ESAs recommend that the European Commission reassess the existence of the two separate concepts of “sustainable investment” as defined in the SFDR and Taxonomy-aligned investment as defined in the EU Taxonomy. The ESAs suggest that the Commission make the parameters of “sustainable investment” under Article 2(17) SFDR prescriptive, addressing the inconsistencies encountered by the current discretion-based approach. For non-taxonomy eligible economic activities and social sustainability, the Commission could utilise other relevant and appropriate sustainability metrics.
Product disclosures – relevant documentation
The ESAs strongly recommend that the Commission ensure sustainability disclosures meet different investor needs. Improvements in these disclosures should consider various distribution channels and ensure consistency of the information provided. The Commission should focus on essential information for retail investors, while professional investors may benefit from more detailed information.
Disclosures for products currently outside the scope of SFDR
The ESAs recommend that the Commission consider including additional products within the SFDR scope to ensure coordinated disclosures. This could include structured products issued under a Euro Medium-Term Note (“EMTN”) programme, which could benefit from sustainability disclosure requirements comparable to SFDR disclosures.
Transparency of adverse sustainability impacts
The ESAs also recommend expanding the current requirements around PAIs. Under the existing framework, the “consideration” of PAIs under Articles 4 and 7 of SFDR is intended to capture the disclosure and mitigation of the PAIs of investment decisions on sustainability factors. The ESAs suggest introducing requirements for the disclosure of information about PAIs, without mandating mitigation in this case. The ESA’s proposal for the Commission includes:
- Making the consideration of PAIs of investment decisions on sustainability factors mandatory for products qualifying for the new “sustainability product” category.
- Mandating information on all PAIs for the “transition” category.
- Requiring minimal disclosures, such as information about select key PAIs, with a list of priority indicators, for all financial products to ensure consistent transparency.
Additionally, the ESAs propose amendments to clarify the drafting of the existing Article 7 SFDR and to refine the sustainable finance framework where there is overlap with other disclosure requirements.
