Current SFDR legislation jeopardises transition finance

The goal behind the sustainable finance agenda in Europe is to improve the transparency and comparability of green activities to minimise the risk of greenwashing and scale up access to finance for the transition to a green, inclusive and resilient economy. However, despite all efforts, this goal has not been achieved. Why? The current approach has an important design flaw.

Many investment products carry the ‘sustainability’ stamp; however, it is questionable whether these products are truly sustainable. Retail investors can often only rely on the name of an investment product to identify whether it is sustainable. It is overly complex and unfeasible for investors to look under the hood of each investment product to identify if investments can be called sustainable. Currently, there is no mechanism in place that penalises investment products that are deceptively labelled sustainable when they are not sustainable at all.

The EU Sustainable Finance Disclosure Regulation (SFDR) was introduced to increase transparency in how sustainability risks and opportunities are integrated into the investment decisions. And this is exactly where the design flaw lies. The sustainable finance agenda is designed in such a way that the burden of proof lies with sustainable investment products. They need to have processes, data and reporting in place to sustain their ‘green’ claims. Even for an impact-driven organisation like Triodos Investment Management, it requires considerable effort to adjust processes and to acquire the data needed to fulfil regulatory requirements, because our own investment approach differs from what SFDR legislation demands from us. This means increasing costs for sustainable investors. No reporting is required if an investment product does not carry the ‘sustainability’ stamp.  Interestingly, it is typically these investment products that do most harm and where the much-needed transition should come from.

What’s more, the current design of the SFDR doesn’t incentivise investors to make their investment products more sustainable as this would mean more work and lead to higher costs. This is exactly the opposite of what we want and what our society needs. We need sustainable investments to become cheaper and harmful investments to become more expensive. Higher costs would then also represent the true price of such investments for society and stimulate a shift from harmful investments to sustainable investments.

Although there is a growth in sustainable finance, financing harmful economic activities continues. The transition to a greener economy is not going fast enough. In March 2022, the Platform on Sustainable Finance published its Final Report on Taxonomy Extension Options  that underlines the need and urgency to speed up the transition to a greener economy. It presents the ambition to classify all economic activities on a scale from harmful, intermediate, neutral to green, with intermediate activities being activities that need to continue to improve their environmental performance levels over time. The report further states that greater transparency is needed on whether financial flows are directed to activities that substantially contribute to solving the environment and climate crisis.

We believe that greater transparency of harmful activities will address the concerns raised above, and we welcome the EU plan to develop Taxonomy extension options. However, we strongly advise taking a simple approach and focusing exclusively on harmful activities. The more categories, the more confusion and the more places to hide. Increasing the reporting burden for the intermediate and neutral categories should also be avoided as these categories aim to improve environmental performance and do good.

Rosl Veltmeijer-Smits, Portfolio Manager at Triodos Investment Management

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