Research from the Sustainable Finance Observatory (formerly 2° Investing Initiative) shows a structural misallocation of impact-oriented retail investment under the current EU sustainable finance regulatory framework.
Half of Europe’s retail investors want their investments to create real-world impact. Yet fewer than 1% of investment products currently allow them to do so. This gap exposes consumers to misleading claims and mis-selling and leaves billions of euros that could support the European Green Deal untapped.
This evidence calls into question whether the EU sustainable finance framework is delivering on the goals first set out in the 2018 Action Plan: Financing Sustainable Growth and reinforced in the Strategy for Financing the Transition to a Sustainable Economy and the European Green Deal.
With the review of the Sustainable Finance Disclosure Regulation (SFDR) now underway, policymakers have a critical opportunity to close this gap.
The Sustainable Finance Observatory has articulated four policy recommendations to address this market failure. These policy recommendations are designed to:
- ensure the sustainable finance regulatory framework correctly allocates impact-oriented retail investment in the EU (therefore effectively contributing to the policy objectives in the Green Deal);
- fit with the Commission’s regulatory simplification ambition; and
- increase EU competitiveness by increasing EU finance sector profits, bringing back more EU shareholder power and boosting growth in the EU impact investing industry. We estimate over €250 billion could be redirected from US to EU fund managers, therefore turning current competitive disadvantages into a competitive edge.
The recommendations are:
RECOMMENDATION 1: The SFDR categories of sustainable financial product should be based on the sustainable investment strategy of a financial product and align with retail investor sustainability-related objectives (i.e. impact and/or alignment).
RECOMMENDATION 1.1: The concept of sustainability-related objectives should be defined in Article 2, Definitions of the SFDR and related regulatory provisions (e.g. MiFID, IDD etc.). The following definition could serve as a starting point:
‘A sustainability-related objective may be either impact-generating or alignment-seeking:
– An impact-generating sustainability-related objective refers to the intention to contribute to positive real-world impacts through the investment process.
– A [value] alignment-seeking sustainability-related objective means aligning the investment with a defined set of sustainability factors.’
RECOMMENDATION 2: Impact-generating financial products should be recognised by additional disclosure requirements under new SFDR categories of sustainable financial product.
RECOMMENDATION 2.1: A new definition for impact-generating financial products should be integrated as a new paragraph in Article 2, Definitions of the SFDR. The following definition could serve as a starting point:
(*) An ‘impact-generating financial product’ has an objective and a strategy of contributing to positive real-world impacts through its investment process alongside a financial risk and return objective.
RECOMMENDATION 2.2: Additional disclosure requirements and minimum criteria for impact-generating financial products should be required in relevant articles defining the new SFDR categories of sustainable financial product at Level 1 (e.g. the proposed ‘sustainable’ and ‘transition’ categories). The detail of these additional disclosure requirements and minimum criteria should be integrated at Level 2, therefore, the following regulatory drafting could be utilised in each article defining the new SFDR categories of sustainable financial product:
(**) Where a financial product [under this article/in this category] is an impact-generating financial product, minimum criteria must be satisfied, and further information must be disclosed to evidence its contribution to positive real-world impacts.
(***) The ESAs shall, through the Joint Committee, develop draft regulatory standards to specify the details of the presentation and content of the information to be disclosed pursuant to paragraph (**) above.
When developing the draft regulatory technical standards referred to in the first subparagraph, the ESAs shall take into account the various types of financial products, their characteristics and the differences between them, as well as the objective that disclosures are to be accurate, fair, clear, not misleading, simple and concise.
The ESAs shall submit the draft regulatory technical standards referred to in the first subparagraph to the Commission by [***].
RECOMMENDATION 3: Additional disclosure requirements and minimum criteria for impact-generating financial products should cover the following generally accepted principles of impact investing:
- Intentionality
- Measurability
- Impact Management
- Reporting
RECOMMENDATION 3.1: A formal expert group should be mandated to research and articulate the additional disclosure requirements and minimum criteria for impact-generating financial products. This could take the form of a Commission Expert Group, or alternatively, the Joint Research Council could be appointed to set up a working group.
RECOMMENDATION 3.2: A ‘credible sustainability-related engagement strategy’ should be defined in Article 2, Definitions of the SFDR for relevant categories of sustainable financial products, and additional disclosure requirements and minimum criteria should be defined for impact-generating financial products which seek to use engagement as a strategy to generate real-world impact.
RECOMMENDATION 4: The MiFID and IDD suitability assessment requirements should be amended and grounded in the sustainability strategy of the financial product and align with retail investor sustainability-related objectives (i.e. impact and/or alignment).
We highlight in this briefing that additionality/investor contribution must be a necessary condition for impact-generating financial products and not an option. With this position, SFO and its partners are raising the bar for all private and public market products which claim to generate real-world impact.
Indeed, our market review on environmental impact claims clearly revealed that most misleading impact claims from listed market funds are claims which equate investing in sustainable companies/activities (i.e. company impact) with generating real-world impact (i.e. investor impact). Yet, while investments in sustainable companies/activities align with the definition of “sustainable investments” under the existing SFDR, impact-generating investments must demonstrate how they intend to achieve and measure the impact they generate [1]. Otherwise, impact investing is not distinguishable from sustainable investing and therefore, impact washing will persist under a new SFDR.
If you would like to endorse these policy recommendations yourself (as an organisation or an individual), follow this link to complete the form.
These recommendations are the result of a wide stakeholder consultation and are already endorsed by leading civil society organisations, academics, and industry groups.
- Better Finance
- WWF European Policy Office
- ShareAction
- Climate & Company
- Facing Finance
- Sustainable Finance Research Group
- Inco Ventures
- FAIR
This project is part of the European Climate Initiative (EUKI) of the German Federal Ministry for Economic Affairs and Climate Action (BMWK).
The opinions put forward in this Policy Briefing are the sole responsibility of the author(s) and do not necessarily reflect the views of the Federal Ministry for Economic Affairs and Climate Action (BMWK).
[1] SFO has developed a science-based framework with criteria to assess the impact potential of financial products (i.e. the potential to achieve any additionality/investor contribution). This Impact Potential Assessment Framework (IPAF) was successfully tested on over 100 financial products.
