The European Parliament may push for increased disclosure and investment requirements for financial products under a new proposed sustainable fund categorization system, according to a new draft report on the review of the Sustainable Finance Disclosure Regulation (SFDR).

Key new proposals outlined in the draft report, filed by Rapporteur MEP Gerben-Jan Gerbrandy, include mandatory Principal Adverse Indicator (PAI) disclosures and reporting on sustainability-related engagement strategies for products utilizing one of the new categories, and a disclaimer for products that refer to sustainability factors but don’t utilize a label under the new categorization system.

The report sets out the Rapporteur’s proposals for Parliament’s negotiating position on the EU Commission’s proposed updates to the SFDR, aimed at helping investors to more easily identify and compare sustainability-focused investment products and invest in line with their sustainability preferences, and to simplify compliance and reporting requirements for asset managers and pension funds.

The Sustainable Finance Disclosure Regulation, in application since 2021, sets out how financial market participants, such as asset managers, have to communicate sustainability information to investors, regarding the integration of sustainability risks and the consideration of adverse sustainability impacts in their processes and the provision of sustainability‐related information with respect to financial products. The goals underlying the introduction of the regulation included helping to attract private funding to facilitate the transition towards greater sustainability, and helping companies pursue transition-related opportunities.

A 2023 review of the SFDR framework by the Commission revealed that the current requirements of the regulation include disclosures that are too long and complex, making it difficult for investors to understand and compare the environmental or social characteristics of financial products. Among the key concerns noted by the Commission was the apparent mis-use of the regulation’s Article 8 and Article 9 disclosure regime as de-facto sustainability labels, which it said may have lead investors to believe that Article 9 funds are necessarily fully sustainable and that Article 8 funds strongly integrate ESG factors, even though this is not necessarily the case, increasing the risk of greenwashing.

To address these concerns, the Commission proposed introducing a new simplified categorization system for financial products making ESG claims, based on three recommended categories, including “Sustainable,” for products contributing to sustainability goals, such as climate, environment or social goals, that already meet high sustainability standards; “Transition,” for products investing in companies and projects that are not yet sustainable, but that are on a credible transition path, or contribute toward improvements in areas such as climate, environment or social areas, and; “ESG Basics,” for products that do not meet the Sustainable or Transition criteria, but integrate ESG investment approaches, such as those focused on best-in-class performers on a given ESG metric, or those excluding the worst ESG performers.

In the new draft report, the rapporteur supports the Commission’s proposal as “an excellent starting point,” but proposes a series of amendments aimed at enhancing transparency, including introducing a set of mandatory PAI indicators for products using one of the new categories to allow investors to compare products within each category, as well as disclosures, on a comply-or-explain basis, describing the engagement strategy pursued by the financial market participant (FMP) and how it has been implemented in alignment with the objectives of the product. For products not categorized under the new system that disclose sustainability factors, the report proposes requiring a disclaimer to make it clear to retail investors that the product does not meet EU standards for defining sustainable financial products.

The report also proposes a new requirement for products under the “ESG Basics” category to eliminate at least 20% of the lowest sustainability-rated securities relative to the investment universe or benchmark.

The new draft report will be presented to Parliament’s Economic and Monetary Affairs (ECON) committee in June, with a vote on the proposals scheduled for mid-July.