Back to Basics
Melville Rodrigues, Head of Real Assets Advisory at Apex Group, says a renewed focus on SFDR’s original goals will benefit investors in real estate and beyond.
Highly critical recent assessments from EU regulators and European Parliament policy experts of the EU’s Sustainable Finance Disclosure Regulation (SFDR) are very welcome: their recommendations must be addressed by the European Commission. SFDR needs to be reformed: the sooner the better.
Last month, the European Supervisory Authorities (ESAs) issued an opinion acknowledging the need to address SFDR’s shortcomings. For instance, regulators highlighted that disclosures to investors required by SFDR “may be complex by nature and difficult to understand”. In addition, while SFDR was designed to enhance transparency around sustainability, Article 8 and 9 disclosure requirements have been used “in marketing material as ‘quality labels’ for sustainability, consequently posing greenwashing and mis-selling risks”.
Experts within European Parliament policy department published this month a study which signalled that SFDR “provisions are too complex, do not work as intended, and interact insufficiently with provisions shaping corporate reporting, indexes, or client preferences”.
SFDR’s original goals
Viewed as a crucial step towards attracting private funding to help Europe make the shift to a net zero economy – one of the EU’s big political objectives – SFDR was introduced with great anticipation in March 2021. The directive was promoted as a crucial step in the defence against greenwashing which has done so much to undermine confidence in ESG.
Key SFDR goals are to help those investors who seek to put their money into projects supporting sustainability objectives to make informed choices. SFDR is intended to allow investors to consider properly how sustainability risks are integrated into the investment decision process.
Recommended revisions
Three years on however, SFDR’s roll-out has been far from smooth. The European Parliament experts’ study recommends revising SFDR to “include more recognisable product labels or categories, enable and foster transition investments, smoothly interact with corporate reporting, and expand the scope of disclosure obligations”.
The regulators’ opinion also brings welcome suggestions, some of which tackle SFDR’s ambiguous language. The ESAs call for SFDR to be updated and introduce “a product classification system, based on regulatory categories and/or sustainability indicators”. Going forward, they note ”[t]he categories should be simple with clear objective criteria or thresholds, to identify which category the product falls into” and the ESAs encourage, at least, categories of ‘sustainability’ and ‘transition’.
Important aims are to reduce greenwashing and make it easier for investors and other stakeholders to discern what constitutes a genuinely sustainable investment. By extension, this would lead to an increased willingness to engage with SFDR and a better ability for funds and others to enjoy the upsides of compliance that is being more attractive to ESG fund flows. The ESAs have helpfully emphasised that SFDR should focus on its core mission: “facilitating capital allocation to sustainable investment.”
The ESAs also highlighted the importance of aligning with global ESG initiatives, recommending greater interoperability with similar efforts in other regions. They noted that “the EU framework does not work in a vacuum, and other jurisdictions are moving in the same direction of considering product categories for retail investors. If feasible, the commission should consider efforts made by jurisdictions such as the UK, the US and recently Australia, to avoid unnecessary duplication and to ease interoperability amongst the various frameworks.” Post-Brexit, EU and UK regulators need to learn from each other to achieve coherence between the Sustainable Disclosures Requirements and the reformed SFDR.
Pressing need
A renewed focus on the original SFDR goals is welcome and particularly relevant to the real estate sector, which, according to the International Energy Agency, accounts for 30% of global final energy consumption and 26% of global energy-related emissions. Clearer objectives could significantly benefit the real estate and fund managers operating in this sector. Capital and investment strategies are needed to drive greater sustainability in real estate and appropriate sustainability labels and disclosures will be crucial.
A reformed SFDR must address the difficulties that currently apply to real estate. For instance, there are differences in the calculation methodologies between the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) and the SFDR, as well as inconsistencies with energy performance certificate (EPC) ratings among European Economic Area (EEA) member states. The real estate sector needs guidance on how to apply the Energy Efficient Buildings Principal Adverse Impact (PAI) to the different methodologies/ratings of the EPC in each EEA member state – and dovetail with the revised Energy Performance of Buildings Directive (which introduces a new ratings system that applies to EPCs from May 2026 (or in certain states December 2029)).
Legislative delivery timescales – including for the reformed SFDR – are pressing: the climate crisis is pressing. Acknowledging the need to address the SFDR’s shortcomings, with both assessments, is a positive step. The study states “a legislative proposal from the commission to amend the SFDR is expected shortly after the next European Commission begins its term”. Now that the 2024 European Parliament election has been cleared and the commission is expected to begin its term in the autumn, let’s hope it will expedite the legislative reform – and not be inhibited by ‘greenlash’ resistance.
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