EU Lawmakers Propose Tougher Fossil Fuel Rules for New SFDR Transition Investment Category

Lawmakers on the European Parliament’s Economic and Monetary Affairs Committee voted today on its proposed negotiating position on changes to the Sustainable Finance Disclosure Regulation (SFDR), the EU’s key legislation setting out how financial market participants have to disclose sustainability information to help investors to identify and compare sustainability-focused investment products and avoid greenwashing.

The proposed position, if approved by Parliament, could set up a challenging negotiation with member states, with the ECON committee agreeing to more stringent criteria than the EU Council for the inclusion of fossil fuel companies in a new “Transition” investment category, including a requirement for companies to channel more capital into sustainable activities than into new fossil fuel projects.

A 2023 review of the SFDR framework by the European Commission revealed that the current requirements of the regulation include disclosures that are too long and complex, making it difficult for investors to understand and compare the environmental or social characteristics of financial products. Among the key concerns noted by the Commission was the apparent mis-use of the regulation’s Article 8 and Article 9 disclosure regime as de-facto sustainability labels, which it said may have lead investors to believe that Article 9 funds are necessarily fully sustainable and that Article 8 funds strongly integrate ESG factors, even though this is not necessarily the case, increasing the risk of greenwashing.

To address these concerns, the Commission proposed introducing a new simplified categorization system for financial products making ESG claims, based on three recommended categories, including “Sustainable,” for products contributing to sustainability goals, such as climate, environment or social goals, that already meet high sustainability standards; “Transition,” for products investing in companies and projects that are not yet sustainable, but that are on a credible transition path, or contribute toward improvements in areas such as climate, environment or social areas, and; “ESG Basics,” for products that do not meet the Sustainable or Transition criteria, but integrate ESG investment approaches, such as those focused on best-in-class performers on a given ESG metric, or those excluding the worst ESG performers.

Under the Commission’s proposal, both the Sustainable and Transition categories would exclude companies expanding their fossil fuel activities, while the Sustainable category would also exclude companies active in fossil fuels or high-emitting energy activities, and the Transition category would have a less restrictive exclusion of companies generating significant revenues from coal.

In June, EU member states adopted their negotiation position on the SFDR updates, which removed the Commission’s fossil fuel exclusion from the Transition category, proposing replacing it with a requirement for companies active in the fossil fuel sector to allocate 20% of their capital expenditure to economic activities aligned with EU taxonomy, and to have a clear, time-bound strategy to reduce Scope 1 and 2 greenhouse gas emissions.

The ECON Committee lawmakers similarly removed the Commission’s exclusion and inserted a 20% Taxonomy-aligned capex requirement for inclusion in the Transition category, but added conditions that would make it more difficult for fossil fuel companies to be included in Transition investment products, with a new requirement for companies to put more capital into sustainable activities than into new fossil fuel projects.

Additional positions approved by the committee included a requirement for ESG Basics products to disclose their exposure to the fossil fuel sector, and for all three categories to exclude investments in companies violating human rights and humanitarian law.

In addition, ECON committee members also proposed that only the largest financial market participants would be required to disclose their impact on environment and society, as well as an exemption for professional investors, and the removal of financial advice and portfolio management from the rules’ scope.

Under the committee’s proposed position, investment companies would need due diligence and monitoring processes for categorized financial products that would be reviewed at least annually, and companies would be required to report on exposure to the fossil fuel sector, greenhouse gas emissions, and activities harming biodiversity-sensitive areas, and to disclose any adverse impact on a product’s ESG objectives.

Rapporteur MEP Gerben-Jan Gerbrandy said:

“From now on, people who choose a sustainable financial product can be certain that their money is actually contributing to a greener economy.”

The proposed position will be brought for approval in Parliament at the start of its October I plenary session.