Hadewych Kuiper is positive about the regulation and its timing: “I find it an exciting and pivotal moment for our industry,” yet she is also concerned about increased greenwashing, a one-dimensional approach, and ultimately that the SFDR will fail to meet its objectives: “If the industry only focuses on labelling and categorising existing products, then no additional money will flow to sustainable solutions. And will the much-needed shift of capital fail to materialise.”

Driving investment towards sustainable development

The Sustainable Finance Disclosure Regulation (SFDR) is the European Union’s regulatory measure to drive investment towards sustainable development. It supports the European Green Deal, the Paris Agreement, and the EU’s goal of being carbon neutral by 2050. Yet ever since its introduction in 2018,the SFDR has faced criticism for flaws in its design, vague definitions, and concerns about data integrity and reliability.

It finally came into effect in March this year, but many have remained uncertain as to whether it will only serve to create more confusion and increase greenwashing. Hadewych Kuiper, Commercial Director, Triodos IM, starts on a positive note about the new regulatory tool: “First of all, the SFDR increases transparency in the sector, which we very much welcome because there are too many products aligned to a marketing hype rather than an authentic ESG investment strategy. The SFDR encourages investors to take ESG considerations into account so they have to shift their thinking. It’s driving the entire sector in the right direction. I find it an exciting and pivotal moment for our industry.”

Kuiper also believes that the timing of the regulation’s introduction is significant. “The SDGs and the Paris Agreement targets are set for 2030. If we want to achieve these goals by then, capital needs to be invested in positive environmental and social objectives now. I very much welcome this chance for the industry, and its timing because the critical urgency at hand.”

Part of a phased approach, financial institutions met the first of their new compliance obligations on 10 March 2021, by self-declaring and categorising their products. They disclosed their investment policies and procedures and described how sustainability and ESG risks are integrated into the investment decision-making process. The same institutions will have to provide more detailed explanations about their measurement and performance in January 2022.

Square peg in a round hole

The SFDR categorisation system classifies regular funds as Article 6, funds that exhibit some sustainable characteristics as Article 8, and funds that focus specifically on achieving a sustainability goal, and for which sustainability is a binding and mandatory part of the investment process as Article 9. All of Triodos IM’s funds were designated as Article 9 products, and while many may have expected this outcome for an impact investor like Triodos, according to Kuiper, it was a challenge: “It may seem logical that our funds would be Article 9, but the response process was quite onerous for us. The regulation was drafted with mainstream markets in mind, not for pure play investors or pioneers like us. We had to align our approach with the SFDR’s wording, and it became a challenging semantics puzzle.”

She explains further: “The regulation takes a risk perspective as its starting point, specifically the risks that could have negative effect on the value of the fund. Triodos IM’s investment strategy and processes are completely opposite. We start with positive impact screening, then mitigate possible negative impacts by applying our very strict minimum standards, and then we manage any residual sustainability risks. Doing it this way means we are less exposed; no exposure to fossil fuels, for example, means no exposure to possibly sharply rising CO2 prices, or not running the risk of assets becoming stranded. We start from 123, while the regulation starts from 321. It was like trying to fit a square peg into a round hole.”

Counter-productive challenges

Kuiper also supports the dynamics of the SFDR, saying: “to not have it would mean the industry would be in a worse situation”. She does however acknowledge that the next phase of implementation will be tough, and that there is a risk that the regulation will not achieve its ultimate purpose. The risks of greenwashing and a one-dimensional market are her key concerns.

Risk of greenwashing

“There are already investment products that are designated as Article 8 or Article 9 status but that don’t have true sustainable portfolios, for example because they include fossil fuels. You only have to look at the top 10 holdings in sustainable indices funds. That’s not how I would explain a sustainable investment product, and it’s this kind of greenwashing that could have an impact on the credibility of the whole industry,” says Kuiper.

“The important distinction with authentic sustainable investors is the intention with which they make their investment decisions. This intention should translate into investment decisions based on impact-risk-return aspects. Without considering impact (positive and negative), the old risk-return adage remains. If the industry only focuses on labelling and categorising existing products, then no additional money will flow to sustainable solutions, and the much-needed shift of capital will fail to materialize.”

One dimensional market

Kuiper believes that there is a risk that the SFDR could end up driving a homogeneous investment market: “There is a risk that all investment products will look the same and invest the same. Not only would the market become less diverse (and hence less resilient), it would also become one-dimensional when it only reports on one metric such as carbon emissions. Of course, environmental solutions are important, but we also have a largescale biodiversity or social inclusion problem in the world, and investors need to take a holistic approach to solve society’s most pressing challenges. That’s Triodos IM’s investment strategy, and it’s why we will continue to disclose the metrics that we think are relevant of our theory of change to spur the transition towards a greener and more inclusive economy.”

Hard yards are yet to come

“At the end of the day, an important first step has been taken, but there is a lot of work ahead,” says Kuiper.

“The next step will be a stricter process and will require more detailed responses. Come first of January 2022, when all the data, all the sources and all the methodologies being used have been explained and validated, we will be able to see what impact the SFDR has had on the industry. Ultimately it will be about whether more capital has truly shifted towards sustainable objectives in time.”