Introduction

The Sustainable Finance Disclosure Regulation (SDFR) first came into effect in March 2021 to help investors understand how their decisions contribute towards the sustainable transition.

The European Commission introduced it alongside the Taxonomy Regulation and the Low Carbon Benchmarks Regulation, a package of legislative measures arising from its Action Plan on Sustainable Finance.  

It requires asset managers to assess and disclose how they consider sustainability risks as part of their investment process, as well as how their investments might impact 18 sustainability factors, known as the principle adverse impact statements (PAIS). 

What is SFDR?

SFDR’s ‘level 1’ regulatory technical standards (RTS) were first applied on 10 March 2021 and required financial institutions to report on the ESG-related activity of the sectors and companies they invest in. 

Level 2 – which came into effect on 30 January 2023 – was designed to supplement the level 1 text, giving more detail on what asset managers will have to disclose and how it should be presented with a focus on sustainability risks, sustainability factors and technical disclosures. 

Asset managers are required to classify funds and ETFs under three main categories depending on their objectives: 

• Article 6: Funds without a sustainability scope (non-ESG) 

• Article 8: Funds that promote environmental or social characteristics (light green) 

• Article 9: Funds that have sustainable investment as their objective (dark green) 

However, a lack of clarity around what can be defined as sustainable investment and concerns about asset managers using the categories as a marketing ploy have led the regulators to conduct a root and branch review of the framework. 

In September 2023, the European Commission launched a consultation on the current regime in a bid to address its shortcomings and over fears it was susceptible to greenwashing.  

The consultation closed in December 2023 and could lead to a legislative review of the framework throughout 2025.  

Impact on ETFs

How an ETF is classified under SFDR has become a key tool for investors when selecting ESG strategies and could determine which strategies see greater flow as the world shifts to a net-zero economy. 

The confusion around much of the regulation – as it has in the mutual fund space – led to a wave of downgrades in the ETF space at the end of 2022 and the beginning of 2023.  

There has also been debate around whether ETFs can be considered Article 9, given the 100% sustainable investment requirements outlined under ‘level 2’. 

Regulatory divergence 

While the European Commission develops a new framework for SFDR, national regulators within Europe have been developing their own sustainability labels for investors. 

It means asset managers need to consider local labelling regimes as well as the overarching SFDR regime. 

For example, France introduced its socially responsible ISR label while Belgium also has the Febelfin ESG label, among many more across Europe. 

The UK has also plunged ahead with its own version of SFDR – the Sustainable Disclosure Regulation (SDR) – unveiling its plans which will label ETFS into one of four categories.