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A-B-E-G-L-N. How adding six letters to SFDR can make it ‘work’.
A-B-E-G-L-N. How adding six letters to SFDR can make it ‘work’.
Florian Heeb
Harald Walkate
By Florian Heeb, Harald Walkate
May 01 2022 · 6 min read

Energy Voices
Sustainability · ESG

We’ve just celebrated the first birthday of the Sustainable Finance Disclosure Regulation (SFDR), and we can observe that few things ‘ESG’ have been the recipient of so much praise, time, effort, attention, and money as the SFDR – and this in just one year. SFDR has been heralded by ESG enthusiasts as a key tool to direct capital towards sustainability objectives, most notably the Paris Agreement and the Sustainable Development Goals (SDGs).

Another key objective of the SFDR is countering greenwashing. However, asset managers, rather than taking SFDR as their cue to do some deep thinking about what makes a product genuinely green, embraced it as a convenient labeling scheme allowing them to sell even more funds as ‘ESG’, but now rubber-stamped by EU regulation.

But even if there has been some criticism to do with these unintended consequences and the “promote” language in Article 8, most have fallen all over themselves to hail SFDR as a key milestone, to become SFDR compliant, and to label as many funds as possible as “Article 8” or “Article 9”.

However, in this hullabaloo, a small but crucial design error has been largely overlooked. We think fixing it is imperative, if SFDR is to be effective in reaching its two key stated goals of (1) directing more capital towards sustainable investments and (2) preventing greenwashing, or protecting consumers’ interests. We also think fixing it is simple and requires just six letters.

First a quick recap: SFDR is the 2021 EU regulation that requires financial firms to publish various things: an ESG policy with information on how they integrate sustainability risks; information on how they consider “principal adverse impacts” of their investments; and remuneration policies that “are consistent” with the integration of sustainability risks.

Firms also need to provide product-, or fund-level information. And this is where the (in)famous Article 6, 8 and 9 classification comes into play: the required disclosures are different depending on whether a fund ‘only’ integrates sustainability risks (Article 6); “promotes environmental or social characteristics” (Article 8); or “has sustainable investment as its objective” (Article 9). All funds need to disclose how sustainability risks are integrated and what their likely impact on returns are (or why those risks are not deemed relevant); Article 8 funds need to disclose how the “ESG characteristics” they promote are met. Article 9 funds need to do even more: they need to explain what their particular sustainable investment objective is, how they intend to achieve it, and also measure and report on progress.

The basic design error lies in Article 9 and has to do with the concept of “impact”.

Even though Article 9 does not mention the word “impact”, it is clear from the text, and from the additional requirements in Article 10, that Article 9 was intended to serve as the category for what the marketplace refers to as “impact investments”. So, investments with the explicit objective to generate measurable and additional real-world impact.

At this point, it is crucial to consider why many consumers, or retail investors, care about sustainable investing, or have a ‘preference’ for sustainable investing, to begin with. The available evidence shows that there are different motivations underlying their preferences. First, there are those who care about aligning investments with their values, who for example don’t want their investments to be associated with tobacco or weapons manufacturers. Second, there are those who care about financial risks and returns and who want to know their bank or pension fund considers ESG, to avoid risky investments (e.g., coal companies that may go out of business in a Net Zero world), or to select firms that perform well on ESG metrics and may therefore also perform well financially. Third, there are consumers who turn to sustainable investments because they want to contribute to a better world, solve society’s problems, help to achieve the Sustainable Development Goals, or facilitate the energy transition. In short, they care about sustainable investing because they want to have “impact”.

Thanks to the 2° Investing Initiative and their study “A Large Majority of Retail Clients Want to Invest Sustainably” we know that, by far, most consumers (at least, in Germany and France) are interested in sustainable investing because of the third reason: because they expect, or are told, that this allows them to have “impact”.

Now, back to Article 9 SFDR.

Article 9 applies when a fund has “sustainable investment” as its objective. And “sustainable investment”, according to SFDR, means an “investment in an economic activity that contributes to an environmental objective or a social objective”. The operative word here is “in”, and we will argue that this word should be replaced. Or rather, should be supplemented with our six letters.

Let us explain.

First, it’s important to consider the difference between company impact and investor impact. Company impact is where a company undertakes impactful activities. For example, it manufactures windmills or solar panels, or it helps socially disadvantaged communities. Investor impact is the change in company impact you, as an investor, induce, or enable, through your investments. The idea here is what, in impact circles, is often called ‘additionality’ – the investment should allow something to happen that would otherwise not happen. There is a causal relationship. Or framed differently: investing in a green firm does not make the world greener, if it does not cause the green firm to grow, or to become greener. And, as our research shows, this additionality strongly depends on the characteristics of an individual investment, and cannot be taken as a given.

Second, you need to know that most funds of the type that are currently classified as Article 9 invest in companies who generally do not have difficulty financing their activities – usually they are publicly listed, very profitable and very large. Also, usually, when these funds invest in those companies, the money to buy the shares does not actually go into the companies – it goes to the seller of the shares, often just another investment fund, a pension fund, or an asset manager. In other words, even if those companies are impactful, they don’t generally need additional financing to be even more impactful, and even if they do, they don’t get the financing by being included in Article 9 funds.

All this is a very roundabout way of saying that:

  • Consumers are drawn to sustainable funds because they want to have ‘impact’; and
  • SFDR Article 9 lets banks and asset managers sell their funds as ‘impact funds’; yet
  • SFDR Article 9 does not actually require there to be ‘impact’; and therefore
  • SFDR does not incentivize banks and asset managers to design funds that in fact direct capital to sustainability goals, and that enable change; and what’s more:
  • SFDR lets financial firms sell ‘impact funds’ to consumers who want to have ‘impact’, and think they are buying ‘impact’, but are, in fact … not getting ‘impact’.

All of this can be quite easily fixed by adding just six letters to the SDFR text: A, B, E, G, L and N. The EU Commission needs to make a tiny change to Article 2 (Definitions), paragraph 17, which defines the term “sustainable investment”: “‘sustainable investment’ means an investment ENABLinG an economic activity that contributes to an environmental objective, (….) or an investment in an economic activity that contributes to a social objective, in particular (… etc.).” In other words, change the “investments in an economic activity” to “investments enabling an economic activity”, and we are all set for a financial market with a vigorous and vital competition to fulfill consumers’ demand for real-world impact.

We believe that this quick fix will go a long way to ensuring that at the second birthday of the SFDR the EU Commission can claim that SFDR is truly incentivizing the financial sector to help direct capital towards environmental and social objectives. And that it can also live up to its promise of end-investor protection. Consumers want ‘impact’, and they will know that Article 9 funds provide it.

Now, how much more impactful than that can you be?

Six letters is all it takes.

You can thank us later.


Energy Voices is a democratic space presenting the thoughts and opinions of leading Energy & Sustainability writers, their opinions do not necessarily represent those of illuminem.

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Florian Heeb
About the authors

Florian Heeb is a researcher at the Center for Sustainable Finance and Private Wealth (CSP) at the University of Zurich. He explores the real-world impact of sustainable investing and how investors integrate impact into their decision-making. Besides his research, Florian serves as a member of the board of directors of ESG-AM. Previously, Florian served as Chief Operating Officer of South Pole.

Harald Walkate

Harald Walkate is the founder of Finding Ways Ahead, an independent ESG and sustainable finance advisory. He is also a Senior Fellow with the University of Zurich Center for Sustainable Finance and Private Wealth (CSP). Previously he was the Head of ESG and member of the Executive Committee of Natixis Investment Managers, and the Global Head of Responsible Investment at Aegon Asset Management.

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