Why Hundreds of SFDR Funds are Reclassifying

Fund classification system

A pressing issue in the world of sustainability is that there are often large data gaps in company reports and sustainability practices. Without proper and standardized data, consumers are unable to make well-informed decisions about where to invest their money, making climate regulation harder to research and implement.

Governments have been attempting to tackle this challenge. One of the most prominent pieces of sustainability legislation in the world is the EU’s Sustainable Finance Disclosure Regulation (SFDR), the first part of which was introduced in 2021. This legislation hopes to standardize reporting on sustainability data and influence companies to increase their reporting.

Legislation like this has helped drive an increase in sustainability reporting. In fact, the Task Force on Climate-related Financial Disclosures (TCFD) found that 60% of surveyed companies disclosed information in 2021, compared to 27% in 2017. These numbers have only since increased.

However, even as more information becomes available, asset managers have been downgrading 70% of their SFDR-compliant ETFs from Article 9 to Article 8. What does this mean, and why is it happening?

Fund Downgrades: What do they mean and why do they happen?

An Article 9 compliant fund has “sustainable investment as its objective”, while an Article 8 fund “promotes, among other characteristics, environmental or social characteristics”. These labels convey how green a fund is and how much its investments are based on an intent to foster sustainable practices.

Likely, this wave of downgrades occurred because of a lack of clarity and stability in SFDR regulations. Existing definitions of sustainability are murky and so are expectations of the SFDR, leading fund managers to take a conservative approach to compliance. Additionally, the European Commission issued new guidance for Article 9 funds in July of 2022, putting the current fund label under review.

Trends like this are only going to get increasingly common. The EU published a new update to their SFDR legislation in 2023, and other countries are in the process of passing their own sustainability disclosure legislation. One thing appears certain, administrative obligations and disclosure needs for asset managers and companies will continue to increase.

Physis Investment can help sort through the ever-growing regulatory landscape. Physis is a fintech company that offers tools and data analytics to track a portfolio’s sustainability performance, which can be invaluable to ensuring compliance.