ESG: PSF report on categorisation of products under SFDR

On 17 December 2024, the EU’s Platform on Sustainable Finance (the Platform) published a report, “Categorisation of Products under the SFDR” (the Report), as part of the European Commission’s review of the functioning of the SFDR.

What’s the background to the Report?

The Platform – an advisory body to the Commission - has been mandated to report on how to enhance the effectiveness of the SFDR and to ensure greater consistency with the rest of the EU’s Sustainable Finance Framework.

As part of its work, it has previously responded to both:

• the European Supervisory Authorities’ (ESAs) April 2023 consultation paper on the SFDR Level 2 RTS (see our client note here) and
• the European Commission’s two consultations (September 2023) on what changes were required to the Level 1 text of the SFDR and how best to improve the overall sustainable finance framework being developed by the EU (see our summary here).

In other relevant work on the SFDR:

• in June 2024, the ESAs published a joint opinion, “On the assessment of the Sustainable Finance Disclosure Regulation (SFDR)”, in which they recommended that the Commission should consider introducing a product classification system – see our summary here.
• in July 2024, the European Parliament published its study, “The current Implementation of the Sustainability-related Financial Disclosures Regulation (SFDR)” recommending changes to the SFDR – our summary of that study is here.

What does the Report recommend?

(a) Product categorisation

The Report proposes a categorisation scheme which would be both (a) based upon a financial product’s sustainability strategy and (b) in alignment with the investor's values or impact objectives - these would be identified through the use of sustainability preferences.

The proposed categorisation scheme is intended to leverage the positive elements of SFDR and the broader Sustainable Finance Framework. It remains high-level and the Report accepts that "further work will be required in order to define or refine thresholds based on real world testing”. Nevertheless, the Platform clearly sees its work as the basis from which to build a complete and detailed categorisation scheme.

The categories set out in the Report have precise minimum criteria, clearly defined objectives, and measurable KPIs and products that fall within each category would measure and disclose their sustainability performance. See Annex A of the Report for guidance on these areas.

The three categories which the Report recommends are the following:

• Sustainable
  Sustainable products would contribute through taxonomy aligned investments or sustainable investments with no significant harmful activities or assets based on a more concise definition consistent with the taxonomy.
• Transition
  This category would include investments or portfolios which support the transition to net zero and a sustainable economy, while avoiding carbon lock ins, in accordance with the Commission's June 2023 recommendations on facilitating financing for the transition to a sustainable economy.
• ESG collection
  A product in the ESG category would exclude significantly harmful investments / activities and invest in assets with better environmental and/or social criteria or applying various sustainability features.

Where a financial product does not fall within one of the three categories above, it would be identified as ‘unclassified’.

The Platform believes that the above categories allow for a differentiation between products that:

• can largely be considered sustainable through their solutions or practices in line with EU classification where it exists (sustainable)
• foster the transition to a net zero and an overall sustainable economy by 2050 and milestones in line with these EU goals (transition) or
• select or exclude sectors or companies based on ESG performance (ESG collection).

It also concludes that, the regime must align aligning investor sustainability preferences with the categories so investors and advisors can easily identify the products that match their sustainability preferences, supported by mandatory disclosures that facilitate this.

The Report states that the proposed categorisation scheme would address SFDR disclosure issues (such as the inappropriate use of SFDR disclosure requirements) while helping to mitigate fragmentation (such as differing national labelling regimes and interpretations by NCAs and other parties), which affects the passporting regime for investment products.

The Report notes the Platform’s belief that financial products which pursue a strategy focusing on social aspects should also be able to fit into the above categories, but it accepts that further work is needed on identifying clear social objectives and indicators within the EU’s sustainable finance framework.

(b) Other recommendations

The Report also recommends:

• a tighter definition of sustainable investment
• evaluating whether the scope of categorisation should go beyond the current SFDR and whether all products and services under sustainability preferences in IDD / MiFID should be categorised
• that the Commission should develop a common understanding on impact investing in the EU’s sustainable finance framework and how this relates to the EU Taxonomy