Position paper on the Joint ESAs Opinion on the SFDR

18.12.2024Position paper

1 Executive Summary
The starting point
The goal
How to get there
2 A system of product classification – inform investors meaningfully and avoid greenwashing
2.1 Product categories: create clarity for investors
2.2 Sustainable product category: make sustainable economy visible
2.3 Transition product category: support the transformation of the economy
2.4 ESG selection product category: keep established criteria
3 Sustainability indicator: preventing false solutions
4 Relevant documentation for product disclosures: provide customised information
5 SFDR-related audits and the role of fund depositaries: enable more effective controls

The transition to a low-carbon, more sustainable, resource-efficient and circular economy is one of the most important measures to significantly reduce the risks and effects of climate change. The aim of the SFDR is to contribute to this and regulate sustainability related disclosure requirements in the financial services sector since March 2021. The idea behind it is to mobilise more capital for the transformation of the economy.

As a result, disclosure standards are harmonised within the EU, making it easier for investors to compare different financial products. Creating transparency as to how sustainable financial products and investment firms are, was and remains the correct approach. The SFDR review, ongoing since September 2023, must be used to implement these guiding principles better and, at the same time, to strengthen the role of the EU as a “global leader in sustainable finance”.

The goal

Investors – retail investors in particular – must be at the centre of SFDR disclosures, enabling them to make well-founded decisions about sustainable investments. Simple and understandable categories for sustainable financial products would help them do so.

Many retail investors nowadays complain about excessive, overly complex and irrelevant information (information overload). This situation inhibits them from making considered and informed decisions about sustainable investments. We need to relieve them of this burden.

How to get there

The EU Commission initiated the review of the SFDR in September 2023. The European supervisory authorities have published comments in their Joint ESAs Opinion (JEO).[1] In addition, the ESMA has published its own position on this issue.[2] The responsible ECON Committee of the European Parliament commissioned a study (ECON Study).[3]

Germany’s private banks have examined these positions carefully. We want to contribute to making better rules that mean more capital flows into sustainable investments. The review must be used to make the SFDR better.

The most important do’s:

Create three categories for products:
- Sustainable product
- Transition product
- ESG selection product
Create clarity and provide customised information for investors:
- Considerably shorten and simplify existing templates
- Remove the PAI statement
- Substantially reduce the 64 PAIs and only use them for products
- Reduce website disclosure requirements for financial products

The most important don’t:

Don’t introduce a sustainability indicator

In detail, this would mean the following:

2 A system of product classification – inform investors meaningfully and avoid greenwashing

JEO 14-25

To date, the SFDR has focussed solely on transparency. But although there are no legally defined product categories, the current disclosures are frequently interpreted as labels. This gives rise to the risk of greenwashing. The EU Commission wants to remedy this situation and has presented two approaches as part of the SFDR review: Either to create completely new product categories, or to further develop the categories based on existing requirements.

The ESAs are in favour of the idea of categorising products. To do this, they recommend using the existing Articles 8 and 9 of the SFDR. Even though this proposal seems sensible, new problems would arise during implementation: The proposed categories do not fit into the existing logic. The review should definitely lead to a simplification. The new product categories should not, therefore, be based on the existing logic but should be created from scratch.

2.1 Product categories: create clarity for investors

The ESAs are proposing to introduce at least the categories “sustainable product” and “transition product”. This proposal goes in the right direction.

However, it would be more prudent to also introduce a third category: “ESG selection product”. This way, all the relevant approaches are covered – taxonomy, ESG and transition.

In addition, it is imperative that the surveying of customers’ sustainability preferences in accordance with MiFID Delegated Regulation 2017/565 is simplified and corresponds with the new categories to be introduced. Only then can customers make considered and informed decisions about sustainable investments. Today this is not the case: The vast majority of investors have stated that they are not interested in taking account of sustainability criteria. The real reason is that the surveying process is much too complex. Various market surveys have confirmed this. But the regulation must not deter investors.

The ESAs have also proposed introducing an “investor’s impact” category as an additional subcategory to the “transition product” category – or as a cross-sectional indicator for all categories. Products in this category should have a positive, measurable impact on an environmental or social objective. However, the inclusion of this criterion would unnecessarily increase the complexity of the categories. In addition, there is no standardised interpretation of this term. An “investor’s impact” should only ever be used as a voluntary criterion.

2.2 Sustainable product category: make sustainable economy visible

For the “sustainable product” category, the ESAs have proposed two elements: These products should include a minimum share of taxonomy-aligned investments. The remaining portion of the investments should at least meet SFDR’s DNSH criteria for environmental and social objectives and good governance – provided that those criteria are more precisely defined in future.

We deem it prudent to introduce a “sustainable product” category. As an alternative to the taxonomy-aligned investments, it should be possible to invest according to the SFDR definition of a sustainable investment.

While it may make sense to use taxonomy-aligned economic activities as a possible basis for a sustainable product, it will be necessary to carefully determine the minimum share for these investments. If the minimum share is too high, then there is a risk that there will be no or only very few sustainable products. The reason: In the EU, only around 30 percent of all economic activities are taxonomy eligible. Consequently, we observe a limited quota of taxonomy-aligned businesses. We do not expect the taxonomy eligibility or taxonomy alignment to rise significantly anytime soon.[4]

As an alternative to using a minimum share of taxonomy-aligned investments as a basis, a broad definition of “sustainable investment” should apply to a “sustainable product”. It would be best to use the current SFDR definition. This is the only way for investments outside the EU and social criteria to be considered sustainable.

Using the current broad definition would also be important for innovations in the area of sustainability. The taxonomy framework is very restrictive, it only defines six environmental goals and a small proportion of economic activities as sustainable. But the fact remains that other economic activities that are not subject to the scope of the Taxonomy Regulation can also be sustainable.

The ESAs also recommend either merging the two criteria “sustainable” and “social” into one category or splitting them into two categories. It is better to differentiate between these two criteria because a social goal is not necessarily ecologically sustainable and vice versa. “Sustainable products” should always include information as to whether they are ecologically or socially sustainable or both. The solution would be to include this information in the templates.

2.3 Transition product category: support the transformation of the economy

For the “transition product” category, the ESAs have proposed a mix of certain criteria: taxonomy, transition plans, decarbonisation goals or a reduction in PAIs at product level. This makes sense, as long as the elements do not have to be considered cumulatively. It would also make sense for this category to disregard the DNSH principle, as otherwise a great many businesses could not be rated transformable. One example: a wind farm operator must use carbon-intensive steel, but it is nevertheless sustainable.

In any case, “transition products” should comply with certain minimum social standards. Of course, child labour and human rights violations must also be excluded in this category.

2.4 ESG-Selection product category: keep established criteria

A large proportion of financial products on offer today disclose their sustainability criteria in accordance with Article 8 of the SFDR. These financial products largely apply exclusion criteria or best-in-class approaches.

In order to allow for sufficient global diversification, particularly for retail investors with small investment amounts, a category is needed which takes these criteria into account. This is because financial products in the two categories “transition product” and “sustainable product” only cover a small share of all investment opportunities in the area of sustainability.

Sustainability has many facets and investors do not think in terms of black and white. They are not interested exclusively in investments that are already sustainable or those that are aimed at sustainability. No, many want to make investments that take general ESG aspects into account. Investors with a preference for sustainability already want to consciously make such investments. This requires a separate “ESG selection product” category – also to take into account the broad range of investor comprehension and to maintain existing investor confidence.

Products in this category must meet the following criteria:

a minimum share of investments pursue sustainability goals or meet environmental or social criteria,
respect exclusions, for example in connection with Climate Transition Benchmarks in accordance with Article 12 of the Benchmarks Regulation (Delegated Regulation 2020/1818),
take account of qualitative ESG factors in the investment process, e.g. ESG ratings.

3 Sustainability indicator: preventing false solutions

JEO 26-37

The ESAs want to introduce a sustainability indicator. This indicator – in the form of a scale – is intended to illustrate the sustainability features of a financial product and thereby reduce complexity. The scale is meant to enable investors to recognise sustainable products more easily. The ESAs see the risk indicator in the PRIIPs regulation or the Energy Performance Certificate for buildings as successful examples.

Whether we share this opinion or not, we must not ignore the fact that any scale only works if it has clear measurement criteria. The two examples mentioned by the ESAs are based on only a small number of parameters that can be determined specifically.[5]

For sustainability, there is nothing like it. A sustainability indicator of this kind would only appear to help investors. In fact, a simple scale simply cannot accurately represent the multifaceted topic of sustainability.

The ESAs acknowledge this themselves and even list a number of risks of using a scale, for example, even more complexity for and insecurity among investors.

It would be better to create meaningful sustainable product categories. This would give investors the guidelines they need.

4 Relevant documentation for product disclosures: provide customised information

JEO 46-48

The ESAs recommend limiting the degree of complexity and amount of information to only what is absolutely necessary. Investors should not be overwhelmed or put off. The European Parliament has also called for the review of the framework to take account of who needs the information and for what purpose.[6]

This makes a lot of sense. Information must be tailored to the needs of the investor and the markets. This also means: reducing reporting requirements instead of increasing them.

Contrary to what the ESMA is calling for, the disclosure of sustainability data should be limited solely to sustainable financial products or those that take certain sustainability criteria into account. It is not helpful to disclose the inclusion of sustainability criteria for every financial product – especially if there is no sustainability data for it. On the contrary, such a requirement would lead to an information overload for the investor. It would also increase the administrative burden, but without the share of sustainable investments rising significantly.

Retail investors need information that is easy to understand and contains the key points. We frequently see retail investors being discouraged by the excessive amount of information. One example: The content of the pre-contractual information and the periodic reports is too detailed and too comprehensive for retail investors. This mandatory information should focus on the key points instead. The dashboard[7] proposed by the ESAs is a good basis for doing this. The current pre-contractual information (templates) should be simplified and shortened based on this dashboard.

The requirement to publish information on portfolio management and special funds on the website should be removed and not replaced. Investors already receive the information before concluding a portfolio management agreement, either as part of the pre-contractual information or for a special funds from the sales prospectus of the capital management company.

Alternatively, it should at least be made clear that the disclosure obligation under SFDR does not apply to financial products that have been customised according to individual specifications for individual investors. These include, for example, customised portfolio management or special funds set up for individual customers. Only customers for whom these financial products were set up can acquire these financial products. Information about such financial products does not provide any additional value for the general public. On the contrary, the additional costs of disclosing such individual financial products discourages providers from expanding their offers of such financial products.

Another example is the “statement on principal adverse impacts of investment decisions on sustainability factors”, the PAI statement. The majority of investors find this information difficult to understand because it is so detailed and complex. The PAI statement does not add value for institutional investors either. Their use of this information is rudimentary, at best. The requirement for the PAI statement can and should be removed.

At the product level, the disclosure of PAIs can provide useful information for investors. But there are far too many PAIs, there are currently 64. Who wants to differentiate between “emission of air pollutants” and “emissions of inorganic pollutants”? No one at all. The same applies to the mandatory disclosure of the different types of greenhouse gas emissions (Scope 1, 2 and 3). This information is far too detailed for investors. If you haven’t studied this topic extensively then it is almost impossible to understand the PAIs or distinguish between them. The solution: Reduce the number of PAIs but increase their meaningfulness.

Investors are essentially interested in these mandatory indicators:

preventing climate change,
preserving biodiversity,
human rights and workers’ rights and
water, waste and resource consumption.

The number of mandatory PAIs should be as low as possible and be limited to these areas. Optional PAIs are unnecessary. This would make it easier to compare products.

5 SFDR related audit and role of funds’ depositaries: enable more effective controls

JEO (Annex I, point d)

The ESAs raise the following questions:

Should SFDR-related disclosure be regulated directly in the SFDR or in sectoral legislation?
What is the role of funds’ depositaries and what SFDR-related disclosure controls are they subject to?

Important to note here: disclosure requirements, particularly for fund products, apply to “financial market participants”. These include capital management companies. Depositaries neither set up nor do they sell or manage the funds. Depositaries are logically therefore not included in the list of “financial market participants” in Article 2 of the SFDR.

While capital management companies primarily make administrative decisions as to how the assets are invested, the depositaries have been allocated a variety of control functions, in addition to acting as custodians, through the relevant legislation, underlying regulatory provisions and other applicable requirements.

Any additional blanket regulatory control obligation for the depositaries with regard to SFDR-related disclosures would be pointless since the depositary is, as mentioned above, specifically not involved in the sales process and would have no influence here. Due to the task assigned to it by law in its role, it is inappropriate for a depositary to interfere in sales processes and doing so would undermine its control function. Controlling sales of investment funds is assigned to the supervisory authority.

As a result, the depositary is not the suitable body for controlling SFDR-related disclosures. An obligation cannot therefore be meaningfully introduced in the SFDR or in sectoral legislation. Consequently, there is no regulatory gap.