SFDR in 2025: fixes, challenges, and what’s next

It doesn’t feel like five minutes have passed since the EU’s Sustainable Finance Disclosure Regulation (SFDR) first became applicable, particularly the product-level disclosures that took effect in January 2023. Expected changes to this framework should be finalized in 2025.

Meanwhile, the UK’s ‘Sustainability Disclosure Requirements’ (SDR) framework has taken a different approach to disclosures. Despite its recent implementation, the UK’s progress has been slow, with limited market uptake and delays in regulatory approvals for sustainability labels.

Furthermore, the UK framework still lacks a taxonomy—a critical component for effective implementation.

In this blog, we explore the key critiques of SFDR, the anticipated changes for 2025, and what these mean for asset managers and other stakeholders.

SFDR: what needs ‘fixing’?

SFDR’s rapid development, driven by the European Commission’s Action Plan on Financing Sustainable Growth, led to a transformative regulation. However, the speed at which it was created left some areas in need of improvement.

We can group these shortcomings into three main categories:

1. Imprecision and Usefulness: Is SFDR impactful and meaningful to stakeholders?
2. Unintended Consequences: What undesirable behaviors and outcomes has it inadvertently encouraged?
3. Transition Shortfall: Is SFDR adequately supporting the sustainable transition?

Imprecision and usefulness

One of the biggest critiques of SFDR is its lack of precision in definitions and its overall utility to stakeholders. For example, its product-neutral design has raised doubts about whether SFDR effectively directs capital toward sustainable investments.

Should SFDR adopt mechanisms to ‘nudge’ markets toward sustainable investment? And how could these incentives be structured, particularly when support for sustainable investments appears to be waning in some areas?

Additionally, SFDR’s templates are overly complex and unintuitive for end investors, especially retail investors. Simplifying these templates, and making them more intuitive, should be a priority in any future amendments.

Unintended consequences

SFDR has inadvertently become a de facto product labeling regime—an outcome that wasn’t originally intended. This shift has sparked debates about whether such a labeling approach, while unintentional, has brought clarity or created additional complexity for stakeholders.

Does this outcome suggest a gap in the regulation’s original design, or does it highlight a broader industry tendency to adapt and interpret frameworks to suit market needs?

Either way, this evolution underscores the need for thoughtful recalibration to align SFDR's objectives with its real-world applications. This issue is compounded by the lack of concrete criteria for fund classification within each ‘category,’ leading to concerns over greenwashing.

More troubling, however, is the phenomenon of ‘green bleaching,’ where funds understate their environmental credentials. This trend invites questions about its root causes—does it stem from gaps in the regulation's design, or does it reveal broader behavioral tendencies within the market?

Such issues suggest a need for policymakers to assess whether SFDR’s structure inadvertently encourages conservative disclosures rather than promoting transparent sustainability efforts.

Regulatory arbitrage—the cost-benefit considerations of categorizing a fund as Article 8 versus Article 9—has played out, resulting in outflows from Article 9 funds and a higher prevalence of Article 8 funds.

Transition shortfall

A fundamental criticism of SFDR is its binary focus on whether an investment is sustainable or promotes environmental and/or sustainable characteristics. Most of the market isn’t already sustainable, yet SFDR does little to support transition finance.

To meet the EU’s ambitious climate goal of reducing greenhouse gas emissions by 55% by 2030 (compared to 1990 levels), an additional €350 billion per year is needed this decade. This financial gap raises a crucial question: Is SFDR equipped to channel investment into this transition, or do we need alternative solutions?

SFDR has been an important step in sustainable finance. However, some argue that its current framework doesn’t fully address the complexities of transition finance. Exploring complementary tools or a more focused approach within SFDR could help bridge this investment gap. SFDR has an opportunity to evolve to better support this transition.

Anticipated changes to SFDR by 2025

Regulators are taking steps to address these critiques. While timing is to be confirmed the European Commission and European Supervisory Authorities (ESAs) are expected to implement the following key changes by:

1. Improved definitions

   The lack of a precise definition for ‘sustainable investment’ has been a major issue. Anticipated updates will align SFDR definitions more closely with the EU Taxonomy. However, practical application—such as the calibration of criteria and thresholds—will be critical to success.

2. Framework alignment

   Better alignment between SFDR and the Corporate Sustainability Reporting Directive (CSRD) is expected, particularly for entity-level disclosures. While these frameworks will remain distinct, there is hope that their disclosures will complement each other more effectively, easing compliance for financial market participants (FMPs).

3. Simplified disclosures

   The ESAs have made suggestions for simplification of the pre-contractual disclosures. This would be welcome but should also be considered in the context of periodic disclosures to ensure consistency.

   Another consideration is the PRIIPs modernization proposal, which proposes some read-across sustainable disclosures. We expect some simplification, but there is a chance there will be more disclosures if PRIIPs bring in some duplication.

4. Introduction of labels

   One of the most noticeable changes expected is the current reliance on Article 8 and 9 classifications as informal labels. We expect there to be a reasonable level of alignment with the UK’s SDR framework, potentially introducing product labels such as ‘sustainable’ and ‘transition’.

   More recognition of the ‘transition’ category would be welcomed, and any alignment with the UK’s approach will prove beneficial for cross-border managers navigating both frameworks.

5. Overall sustainability indicator

   A proposed ‘bottom-line’ sustainability indicator could enhance the clarity of disclosures. This might include metrics such as financed emissions or decarbonization targets, presented in an intuitive format like color coding or letter grades. However, the design must avoid introducing further confusion.

6. Mandatory PAIs for sustainable funds

   There is potential for mandatory disclosure of Principal Adverse Impacts (PAIs) for funds classified as sustainable. This baseline set of metrics could standardize reporting and improve comparability.

Looking ahead

For the next major milestone, all eyes are on the Level 1 review proposal. We expect this to be published around mid-2025 based on ESMA’s sustainable finance implementation timeline.

We’ll continue to provide updates and analysis as these changes take shape, helping clients, like you, stay ahead of the curve. If you have questions or need more information, please contact us for personalized support.