Article
4 min

How Can Regulation Become a Valued Asset for Sustainable Finance Actors?

While European regulations are attempting to provide a framework for the booming sustainable finance sector, major challenges remain, including the risk of greenwashing and the need for a common language.
Written by
Raphaèle Védy
Published on
5/7/2024

National and European regulations have played a central role in the emergence and development of sustainable finance. Currently, sustainable finance relies on a hybrid model that combines regulatory obligations with the ambitions of financial actors.

This paradigm remains improvable: financial market players struggle to adopt existing regulations and many encourage the development of more incentive-based regulations. The consultation on level 1 and the review of level 2 of SFDR reflect this desire. The goal of these proposals is to encourage actors to adopt sustainable investment strategies while limiting associated risks, such as the risk of greenwashing.

To achieve this balance, it is essential to introduce a common language for financial actors and savers. This language can guide the financial sector and support savers in their investment decisions.

1. SFDR and Taxonomy: the failure to create a common language?

1.1. The genesis and usage of SFDR: when regulation goes astray

SFDR aimed to establish this common language. To do so, regulators defined reporting models to ensure greater transparency and limit greenwashing. The regulation distinguishes two types of ESG financial products: “Article 8” funds and “Article 9” funds. Article 8 funds promote environmental and/or social characteristics, while Article 9 funds aim for 100% sustainable investments; in theory, their ESG ambition level is higher than that of Article 8 funds.
 

The study conducted by WeeFin in 2024 on 70 funds highlights shortcomings in the use of SFDR typology. Most of the Article 8 and Article 9 funds we studied face a risk of greenwashing. This risk stems from the gap between the applied investment strategy and the requirements associated with their SFDR category. Thus, in practice, SFDR struggles to increase the transparency of financial products and limit greenwashing.

The consultation initiated in 2023 by the European Commission on SFDR level 1 proposes two solutions: 

  • Maintaining Articles 6, 8 and 9, which would become labels associated with minimum requirements; or 
  • The creation of four new labels (transition, exclusion, thematic, impact). 

Both proposals rely on a labeling system. However, at WeeFin, we do not believe such a system will lead to more virtuous financial practices, as it does not guarantee the existence of the common language necessary for transparency and comparability of financial products. 

In our response to the consultation, we instead propose creating a reporting model applicable to all funds—whether they consider ESG criteria or not—associated with minimum communication requirements. This template could integrate new information, such as the brown share or the exclusion thresholds applied by the portfolio. 
 

These data could facilitate the comparison of financial products as a whole and guide investors and savers towards products aligned with their own ambitions. Moreover, the obligation to report standardized data would encourage non-ESG actors to engage more to increase their market competitiveness.

 

1.2 Taxonomy: a transparency project that hasn't (yet) succeeded

The European Taxonomy aimed to list “green” activities by defining a set of quantitative criteria for each activity. This regulation was supposed to enable financial actors to identify and invest in sustainable assets.

However, our study reveals that most asset managers do not wish to or cannot make significant commitments regarding the taxonomic alignment of their assets. Only 11% of the funds studied have a non-zero taxonomy alignment commitment. Moreover, the financial product with the highest commitment (5%) failed to meet its objective. 

This lack of commitment reflects a lack of available data rather than a lack of ambition on the part of management companies. This is why the CSRD regulation was created, with the aim of providing actors with a wide variety of non-financial data. CSRD requires European or European-active companies to publish the environmental information necessary to calculate their taxonomy alignment. Thus, it will help investors address the current data shortage.

While waiting for the full implementation of CSRD, it is essential to continue encouraging transparency by publishing alternative information. Among the proposed solutions, WeeFin considers the ESA’s the most interesting. It involves communicating on greenhouse gas emission reduction targets at the financial product level, which could allow for evaluating and comparing the transition potential of products. 

 

2. The importance of defining existing concepts

Sustainable investment: one concept, multiple interpretations

Clearly defining existing concepts is necessary before introducing changes in reporting requirements. In particular, the notions of DNSH and sustainable investment are still poorly understood by actors and therefore subject to a high risk of greenwashing.

As a reminder, SFDR defines a sustainable investment in terms of several minimum requirements:  

  • Using quantifiable indicators to measure contribution to an I/O objective
  • Taking DNSH into account
  • Evaluation of good governance activities 

These criteria were intended to guide actors in constructing their own definition of sustainable investment. However, this framework remains very vague and does not define transparency obligations, which does not allow for effectively comparing the ambition levels of management companies. 

An analysis of strategies reveals significant differences in ESG ambition between funds, but this difference is not always visible to the investor. For example, consider two funds: 

  • an A fund with a minimum 10% commitment to sustainable investment, whose SI definition is based on very precise metrics and thresholds; and 
  • a B fund with a sustainable investment commitment of 30%, but whose definition of sustainable investment is based solely on a qualitative analysis whose methodology is neither systematic nor formalized. 

It is possible that Fund A's commitment leads it to be composed of assets aligned with a more ambitious ESG strategy than those of Fund B. However, without a precise and common reporting framework, the investor is not able to identify this difference and invest according to their extra-financial ambitions.<br>

The results of our study illustrate these disparities among funds. On the one hand, we found that 41% of Article 9 funds do not have quantifiable indicators to measure an asset’s contribution to an E/S objective. On the other hand, 66% of Article 9 funds are not transparent about their method of considering PAIs for the DNSH test. 

It is therefore crucial to clarify the definition of sustainable investment and impose more standards on the expected level of transparency. The overhaul of SFDR is thus welcome if it addresses both the lack of clarity in classifications and the lack of clarity of key concepts.

 

Monthly newsletter
Subscribe to our newsletter to receive our latest publications.
Learn more about our privacy policy
Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

Discover our content

Case Study

Article 29 LEC: Deciphering the reports published in 2023

Download our analysis of Article 29 LEC reports published in 2023.
Read the publication
Article

Sustainable finance: Switzerland is no exception

In 2019, Switzerland, a long-standing player in the financial sector, committed to achieving zero net greenhouse gas emissions by 2050. Finance represents a significant lever for action in achieving its climate objectives. Find out more about the various standards already in place and those to come.
Read the publication

Discover the benefits of ESG Connect

Subscribe to the newsletter
Subscribe to our newsletter to receive our latest publications.
Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.