Sustainable Finance Disclosure Regulation directs capital towards sustainable targets but fails at providing transparency – Tutkimustietoa Finsif-stipendiaateilta 2024

As the demand for sustainable investment targets grew during recent years, also greenwashing within financial markets surfaced as a novel issue. Responding to the lack of related regulation, the EU introduced Sustainable Finance Disclosure Regulation (SFDR) in 2021. SFDR aims to improve comparability and transparency among sustainable investment targets by setting unified disclosure requirements and implementing a classification system for distinguishing differences.

SFDR classification system separates funds into three categories based on their sustainability ambitions. Previous studies suggest that funds labeled as sustainable may attract higher fund flows than similar funds without a label. On the other hand, literature on SFDR is scarce, and results on its effectiveness in steering funds’ investment behavior have been contradictory. Recently, news outlets as well as academic literature have raised concerns on the accuracy of sustainability labeling, driving the motivation for this study. Even though SFDR classifications are regulatory labels, the classifications are assigned by funds themselves instead of regulators, creating a potential conflict of interest.

In my thesis, I investigate whether SFDR is effective in shaping the behavior of funds and investors, as well as in improving transparency. The studied sample includes monthly observations of ~4 500 European mutual funds from 2019 to 2023. The impact of SFDR was assessed first by studying if SFDR implementation has affected the portfolio carbon emission levels of funds, and then evaluating the effect of SFDR classification labels on attracted fund flows. Additionally, SFDR’s impact on transparency was evaluated by studying whether the declared classifications align with the actual environmental commitments of the funds.

First, I find that SFDR has improved fund sustainability, observing a clear decrease in portfolio carbon emissions after SFDR level 2 requirements came into force in January 2023. The results also show that the majority of the change is driven by emission decreases of Article 6 funds, indicating that the regulatory effect if strongest on the least sustainable funds, as desired. The reasoning behind these improvements is likely twofold: opportunity to receive Article 8 classification acts as an incentive, and on the other hand, having to frequently disclose undesired information is considered too damaging.

Thirdly, funds labelled as sustainable by SFDR seem to attract higher net flows, even when controlling for other sustainability labels. This indicates that investors may value regulatory labels over other ESG labels in decision-making. Therefore, this suggests that the SFDR sustainability label is financially beneficial for funds. Finally, I also find evidence that a significant proportion of funds classified as sustainable by SFDR (excluding impact funds) are still engaged e.g. in carbon and fossil fuel intensive investments, contrary to environmental sustainability objectives. This shows that the SFDR label should not be interpreted as an accurate assessment of fund sustainability, as it leaves room for greenwashing.

To conclude, my thesis adds to the limited literature on SFDR’s effects. Considering the novelty of regulation and limited data availability, a comprehensive picture of SFDR’s impact on sustainability cannot yet be built, but the results provide initial evidence on the impact of SFDR level 2 implementation. This study suggests that SFDR has been effective in directing capital towards more sustainable targets, both from the perspective of funds and investors. However, the objective of improving transparency has not been fully met, as the ambiguity of definitions still allows for environmentally unsustainable investments to be classified as sustainable.

Helmi Peräkylä
Aalto University

The study can be found here.