latamen
SFDR classification: ‘Good things take time’

SFDR classification: ‘Good things take time’

08-04-2022 | Insight
Labelling funds according to their true level of sustainability under the EU’s Sustainable Finance Disclosure Regulation (SFDR) isn’t as easy as it looks. In this update, Carola van Lamoen, Head of Sustainable Investing, Anouk in ‘t Veld, SFDR classification specialist for the Robeco product management team, and Kenneth Robertson, client portfolio manager with the Robeco SI Center of Expertise, explain why it’s taking some time to unravel.
  • Carola van Lamoen
    Carola
    van Lamoen
    Head of Sustainable Investing
  • Anouk in 't Veld
    Anouk
    in 't Veld
    Active Ownership Specialist
  • Kenneth Robertson
    Kenneth
    Robertson
    Client Portfolio Manager - Sustainable Investing

Speed read

  • SFDR classifies investment funds as either Article 6, 8 or 9
  • In a dense forest, it’s hard to determine the different shades of green
  • Shift in focus from labelling to characteristics would be welcome

The SFDR classification process: a refresher

In March 2021, the Level I requirements of the SFDR came into force. Amongst other things, the SFDR requires asset managers to classify their funds according to three Articles of the new pan-European directive. Under this system, a strategy is labelled under either Article 6, 8 or 9:

  • Article 6: funds that have no sustainability focus
  • Article 8: funds that do not have a sustainable investment objective, but do promote environmental or social characteristics, provided that the companies in which the investments are made follow good governance practices
  • Article 9: funds that have a sustainable investment objective.

As of January 2023, new regulatory elements are to be introduced as part of the SFDR Level II implementation, that cover, but are not limited to, the intended percentage of sustainable investments; the minimum intended investment in EU Taxonomy-aligned investments; and the consideration of Principal Adverse Impacts (PAI).

Those elements will also need to be considered in the light of amendments to the MiFID II regulatory directives as an element of the so-called sustainability preferences in suitability assessments for portfolio management and investment advice.

It is expected that the SFDR Level II requirements might alter current classifications, as well as replace the focus on classifications towards the underlying elements, such as the percentages of sustainable investments and Taxonomy alignment prevailing in funds.

Stay informed on Sustainable Investing with monthly mail updates
Stay informed on Sustainable Investing with monthly mail updates
Subscribe

In a dense forest, it’s hard to determine the different shades of green

The shift in focus from classification to the underlying characteristics of the invested assets aims to improve on the current system. Here, trying to place a variety of funds with unique characteristics into just three groups is considered by many investors to be too simplistic to capture this diversity.

In addition, the focus on this kind of classification might not have been what was originally intended in the pursuit of transparency and disclosure. One of the often-cited challenges is the one that the ‘bucket’ of Article 9 classifications is rather small as it is fully tailored to funds that are entirely sustainable. In contrast, the group of Article 8 funds encompasses a large amount of funds.1

Some of these Article 8 funds may promote environmental or social characteristics that relate to exclusions only. Others are actively financing companies that are required to transition towards achieving the objectives of the Paris Agreement or those of the 2030 Agenda for Sustainable Development. The disparity is quite wide.

Helping with the transition

A potential paradox is that certain funds seek to actively engage with companies that are transition candidates, or invest in companies whose current activities are not entirely sustainable, but are allocating significant capex to the transition. These are classed as Article 8 funds, yet they might be considered as more impactful than other funds in the Article 8 bucket

However, so long as significant capital is allocated to transition strategies, and SFDR works as intended, more holdings should eventually become eligible to classify as sustainable investments, and with that, the number of Article 9 funds might grow over time.

In that sense, the consultation of the UK’s Financial Conduct Authority (FCA) outlining the direction of Sustainability Disclosure Requirements (SDR) and investment labels for British funds might offer a clearer distinction. This has five buckets labelling funds as ‘not promoting SI’, ‘responsible’, ‘transitioning’, ‘aligned’ and ‘impact’.2

From labelling to matchmaking

The likely shift in focus from classifications to sustainability assessments, driven by SFDR Level II and MiFID II implementations, would be welcome. For MIFID II, the underlying sustainable preferences of clients need to be matched with the products they buy, and the subsequent level of Taxonomy alignment will need to be considered. Clients will also need to indicate whether funds should consider PAIs, which can beautifully capture investment preferences with regard to tackling environmental and social issues.

This should help to better articulate what type of sustainability goals the end-investor is looking for, and bring more nuance to the type of product being sought, especially within the range of Article 8 products.

However, there is a catch. Whereas the frameworks for the Taxonomy and PAI leave little room for doubt, the definition of sustainable investments is open to interpretation. This might result in a variety of opinions about which holdings are deemed to be sustainable, and whether this should be considered from a universal or a contextual perspective.

From a universal perspective, an investment is either considered to be sustainable, or it is not. From a contextual perspective – following the principle-based definitions provided – one could argue that an investment can be considered sustainable for one fund but non-sustainable for another.

For example, a fund that aims to finance the transition to a low-carbon world could invest in companies with verified decarbonization pathways, but which may have average practices with regards to diversity and inclusion. A fund which aims to invest in companies with leading diversity and inclusion practices would be unlikely to buy the same companies. It depends on the underlying sustainability objective, with the minimum safeguard that the companies do not significantly harm any other sustainability objectives, and follow good governance practices.

Good things take time

Ultimately, we believe that the full publication and implementation of the EU’s Environmental and Social Taxonomy will work as a proxy for what is considered sustainable, thereby contributing to the intended goals of the Sustainable Finance Framework by increasing comparability between sustainable products, and avoiding greenwashing.

However, until this harmonization and standardization is provided, and the related data challenges have been tackled, we would advise investors to carefully research every product they are considering buying. Be sure to look under the proverbial hood.

1https://www.morningstar.com/en-uk/lp/sfdr-article8-article9?utm_medium=native&utm_campaign=emea_investors_sites
2https://www.fca.org.uk/publications/discussion-papers/dp21-4-sustainability-disclosure-requirements-investment-labels

Logo

Important information

The Robeco Capital Growth Funds have not been registered under the United States Investment Company Act of 1940, as amended, nor or the United States Securities Act of 1933, as amended. None of the shares may be offered or sold, directly or indirectly in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act of 1933, as amended (the “Securities Act”)). Furthermore, Robeco Institutional Asset Management B.V. (Robeco) does not provide investment advisory services, or hold itself out as providing investment advisory services, in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act).

This website is intended for use only by non-U.S. Persons outside of the United States (within the meaning of Regulation S promulgated under the Securities Act who are professional investors, or professional fiduciaries representing such non-U.S. Person investors. By clicking “I Agree” on our website disclaimer and accessing the information on this website, including any subdomain thereof, you are certifying and agreeing to the following: (i) you have read, understood and agree to this disclaimer, (ii) you have informed yourself of any applicable legal restrictions and represent that by accessing the information contained on this website, you are not in violation of, and will not be causing Robeco or any of its affiliated entities or issuers to violate, any applicable laws and, as a result, you are legally authorized to access such information on behalf of yourself and any underlying investment advisory client, (iii) you understand and acknowledge that certain information presented herein relates to securities that have not been registered under the Securities Act, and may be offered or sold only outside the United States and only to, or for the account or benefit of, non-U.S. Persons (within the meaning of Regulation S under the Securities Act), (iv) you are, or are a discretionary investment adviser representing, a non-U.S. Person (within the meaning of Regulation S under the Securities Act) located outside of the United States and (v) you are, or are a discretionary investment adviser representing, a professional non-retail investor. Access to this website has been limited so that it shall not constitute directed selling efforts (as defined in Regulation S under the Securities Act) in the United States and so that it shall not be deemed to constitute Robeco holding itself out generally to the public in the U.S. as an investment adviser. Nothing contained herein constitutes an offer to sell securities or solicitation of an offer to purchase any securities in any jurisdiction. We reserve the right to deny access to any visitor, including, but not limited to, those visitors with IP addresses residing in the United States.

This website has been carefully prepared by Robeco. The information contained in this publication is based upon sources of information believed to be reliable. Robeco is not answerable for the accuracy or completeness of the facts, opinions, expectations and results referred to therein. Whilst every care has been taken in the preparation of this website, we do not accept any responsibility for damage of any kind resulting from incorrect or incomplete information. This website is subject to change without notice. The value of the investments may fluctuate. Past performance is no guarantee of future results. If the currency in which the past performance is displayed differs from the currency of the country in which you reside, then you should be aware that due to exchange rate fluctuations the performance shown may increase or decrease if converted into your local currency. For investment professional use only. Not for use by the general public.

I Disagree