Parliament's SFDR review position: tougher tests for Transition, too little for ESG Basics

Key concern: ESG Basics does not give retail investors a clear view of performance

Frank Bold's research on products marketed under the current SFDR found that Article 8 products are frequently confusing and at times misleading, in particular as regards the disclosure of performance. The review was intended to resolve this by giving retail investors products whose character and performance can be understood and compared. ESG Basics, which succeeds Article 8, does not yet achieve this.

• Allocation criteria: The 70% test can be met through outperformance of an ESG rating, outperformance on indicators selected by the manager, a proven track record, or "other investments" accompanied by a justification. Each route relies on a methodology chosen by the manager, so results are not comparable across products. Parliament's requirement that "other investments" be justified "in light of" the other listed criteria improves the position only marginally.

• Disclosure baseline: PAI indicators are the only common signpost in the framework. Parliament requires a single indicator for ESG Basics, exposure to the fossil fuel sector, while the Commission and Council require none. The indicator is a step forward but has limited informative value for retail investors. It does not describe a fund's emissions and it does not capture high-emitting activities outside the fossil fuel sector, such as data-centre-intensive IT companies. A mandatory GHG emissions indicator, selected for materiality, would address this directly.

• Fewer safeguards: Transition and Sustainable products are subject to further safeguards, including stricter exclusions, capex conditions and three or four mandatory indicators. ESG Basics has fewer, so disclosure of performance is key.

• Risk of perpetuating the catch-all: Without a stronger disclosure baseline, ESG Basics risks reproducing the situation of Article 8 under SFDR 1.0 - a broad catch-all standard, built on weak and heterogeneous sustainability criteria, that captures a large share of the market by default and does not distinguish levels of ambition. Unless this gap is closed, the improvements achieved elsewhere in the text will have limited effect for retail investors choosing among ESG Basics products.

Other serious concerns

• AIF opt-out: The opt-out allows AIFs offered exclusively to professional investors to disapply Articles 6a, 7, 8 and 9. Its necessity is unclear, since a fund that makes no category claim already falls outside Articles 7 to 9. In practice it removes the safeguards of Article 6a for non-categorised products: the 10% content cap, the requirement that disclosed information accurately represent the composition of the fund, and the clause against reference to weaker third-party labels. Institutional investors, including pension funds, rely on comparable sustainability information on the AIFs they hold. Parliament's version is narrower than Council's because it does not list Article 13(3), but the application of the naming ban to opted-out funds remains uncertain, since Article 13(3) refers to products "referred to in Article 6a".

• Climate benchmark bypass: Parliament follows the Commission in deeming products that use an EU climate benchmark to meet all conditions of the category, including PAI disclosure. Council confines this to points (a) to (c) and preserves PAI disclosure.  

• Fossil fuel expansion: Parliament's four cumulative conditions for Transition are more demanding than Council's two, but none of them caps absolute fossil fuel exposure or new fossil fuel investment. The capex test compares ratios, and the Scope 1 and 2 strategy leaves Scope 3 emissions outside the test, although these typically account for vast majority of an oil and gas company's footprint. Transition products may therefore continue to hold companies that expand fossil fuel production, with exposure to risk of stranded assets.

What works

• Transition category: Parliament retains the coal power phase-out condition that Council deleted and adds a comparison between Taxonomy-aligned capex and capex for new fossil fuel projects. Together with mandatory PAIs on fossil fuel exposure and GHG emissions, this makes Transition a sound element of the review, subject to the limitations noted above.

• Mandatory PAIs: PAI disclosure becomes mandatory for Transition and Sustainable, with four fixed indicators for Sustainable: fossil fuel exposure, GHG emissions, biodiversity-sensitive areas and compliance monitoring under the UN Guiding Principles and OECD Guidelines.

• Engagement: A description of the engagement strategy becomes mandatory in all three categories.

• Human rights exclusion: The exclusion is aligned with the UN Guiding Principles and applies to all categories.