Europe must not put a regulatory seal on greenwashing

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

This was the promise made by Gerben-Jan Gerbrandy, the European Parliament’s lead negotiator on reforming the Sustainable Finance Disclosure Regulation (SFDR), after its economic affairs committee adopted his compromise position. The reform may be warranted. The certainty not.

SFDR was meant to help investors assess how products take sustainability into account. Its standardised reporting was long and difficult for non-specialists to use and compare. Its disclosure categories became unofficial labels on which claims about different shades of green were built—claims the framework could not support.

The proposed reform would streamline reporting and replace these accidental labels with three official categories: Sustainable, Transition and ESG Basics. Each would be backed by minimum qualification criteria: exclusions, thresholds and recognised investment routes, plus specific disclosure requirements.

Simpler information and credible minimum conditions are welcome. They can make products easier to identify and compare, facilitate supervision and curb the most obvious greenwashing.

But official categories also raise the stakes. They are a first signal of a product’s purpose, but for many investors also the last point of reference. Providers, meanwhile, will have incentives to meet the conditions for qualification at least cost. The more readily a category substitutes for scrutiny, the more closely its promise must correspond to what qualifying products are permitted to do and can reasonably achieve. Qualification criteria must set a credible floor for quality, not merely determine the cheapest route to a marketable category.

SFDR category names imply something about the investment approaches that may qualify and shape retail investors’ expectations. Its preamble links financial products to mobilising capital for the Union’s sustainable prosperity. Mr Gerbrandy turns that ambition into a promise of delivery. That is more than a framework based on minimum eligibility criteria can establish—or this revision, as drafted, can deliver.

The problem is twofold. First, the qualification criteria do not always exclude products that conflict with the expectations created by a category. Second, meeting them does not establish alignment with the real-economy ambitions regulators invoke.

Consider the proposed Transition category. The European Commission’s proposal excluded companies developing new fossil-fuel projects. Member states substituted conditional eligibility for that exclusion, an approach Parliament has retained.

General investments in fossil-fuel companies may qualify for a Transition product if the issuer devotes at least 20% of capital expenditure to EU-taxonomy-aligned activities and, in Parliament’s version, more to those activities than to new fossil-fuel exploration and production projects. That is diversification, not transition.

The energy transition means low-carbon energy replacing fossil fuels, not merely growing alongside them. Investors may reasonably expect Transition funds to support the fossil-fuel phasedown required by climate objectives, rather than finance further expansion. The category fails that elementary test.

Such misalignment may be political, as here, or the product of honest miscalibration. But even well-designed criteria have limits: they can serve as necessary gatekeepers, but not as proof of alignment with the regulation’s purposes or of effective contribution to the outcomes the category implies or lawmakers promise.

Portfolio-emissions targets illustrate the point. One possible route to qualification for the Transition category is reducing average portfolio emissions intensity at a rate resembling that in a global net-zero scenario. But a provider can achieve this simply by reducing exposure to the most carbon-intensive sectors and companies, regardless of their importance to the transition, transition performance or even actual decarbonisation. That may reduce the product’s carbon-price risk, but it does little to direct capital towards activities that need transition finance or reward real-economy progress.

The result is that financial products with little or uncertain contribution to the transition can sit alongside products that genuinely support it in the same category. Unless the framework distinguishes between them, the former—often cheaper to design—are likely to proliferate, diluting the category’s meaning and penalising providers that genuinely seek to finance the transition.

The answer is not a more prescriptive rulebook. Categorisation is not product specification. The transition can be financed through different strategies, and the regulation is right to leave room for them. But such flexibility requires substantiation. Every product claiming a category should explain how the objectives it pursues reflect those represented by the category; how its investment strategy and implementation pursue those objectives; why its performance indicators are relevant; and, where real-economy effects are invoked, why they are plausible.

That would give investors and supervisors the information needed to distinguish credible strategies from weaker ones, improve market practice and inform future regulatory revisions. It is the coherence test SFDR needs alongside formal investment criteria.

Final negotiations between Parliament and member states still leave time to align formal criteria with category objectives and strengthen transparency requirements with a coherence test.

Without both, the EU risks turning a framework intended to curb greenwashing into one that gives it an official seal.

Frédéric Ducoulombier,
Programme Director, Climate Regulation and Policies, EDHEC Climate Institute, EDHEC Business School, Nice, France  
[email protected]