SFDR 2.0: Aligning product design, data reality and the transition agenda

The review of the Sustainable Finance Disclosure Regulation (SFDR) marks an important step in the evolution of the EU sustainable finance framework. Nearly five years after its entry into force, the reform aims to improve transparency, enhance comparability and strengthen confidence in sustainability-labelled investment products.

As policymakers refine the future shape of the SFDR, calibration will be critical to ensuring the framework can both uphold credibility and support capital allocation towards the transition. Our impact analysis across global, developed and emerging listed equity market universes illustrates why this balance matters.

Sustainable investing has evolved rapidly over the last decade, with asset owner adoption increasing from around 50% [note1] in 2019 to 73% today[note2] .As investors are increasingly focused on financing real-world decarbonisation, clearer product categories would help improve transparency and comparability across sustainability-labelled products.

However, the transition to a low-carbon economy will not be delivered by green assets alone[note3]. Sectors such as Energy, Utilities and Basic Materials remain central to industrial decarbonisation, infrastructure development and energy security.

This reflects the reality that transition investing is not limited to green assets but also includes the essential financing of high emitting sectors as they decarbonisate to support the shift toward a low carbon economy across sectors.

Transition investing requires exposure to sectors central to infrastructure development, industrial transformation and energy system evolution. New exclusions, including the “no new fossil fuel projects” requirement, may limit investment in companies enabling the low-carbon transition.

The calibration of thermal coal exclusions will also remain important in balancing transition objectives with regional and sector-specific realities, where they may lead to reduced investment universes and the ineligibility of companies or entire sectors that are important for the transition to a low-carbon economy. 

Under the current SFDR proposals, eligibility for the ESG (Article 8), Transition (Article 7) and Sustainable (Article 9) categories is partly defined through exclusion criteria, including restrictions on thermal coal exposure and on companies involved in new fossil fuel projects. Applying these proposed exclusions across global, developed and emerging listed equity market FTSE universes illustrates this challenge clearly [note4]:

• In the FTSE Emerging universe, the proposed Sustainable and Transition exclusions would remove more than 20% of the index weight.
• In developed markets, approximately 12% of the FTSE Developed Europe index weight would be excluded under the Transition category. Around 14% of the same universe would be excluded under the Sustainable category.
• Exclusions linked to thermal coal and “no new fossil fuel projects” have particularly significant impacts across the Energy, Basic Materials and Utilities exposures.
• The analysis also shows that the “no new fossil fuel projects” requirement may reduce the differentiation between the Transition and Sustainable categories, potentially limiting the practical role of transition-focused investment strategies.

These results highlight the importance of ensuring that transition criteria remain aligned with real-economy decarbonisation pathways. Global transition investing requires sufficient flexibility to reflect differing regional realities and decarbonisation trajectories.

In current proposals mean that some of the sectors most critical to the transition, including Energy, Utilities and Basic Materials, could become under-represented in transition strategies, limiting the ability of investors to finance the infrastructure and industrial transformation required for decarbonisation.

The current proposals for Transition and Sustainable categories focus largely on EU Green Bond-aligned instruments or equivalent labelled issuance. However, this does not fully reflect how sovereign transition financing occurs in practice.

Government budgets, which are primarily financed through general-purpose sovereign issuance, remain the main channel for large-scale transition investment. By comparison, the green bond market, including the EU Green Bond segment, remains relatively small and less liquid.

This is even more the case in some emerging markets, where labelled sovereign issuance remains limited, despite significant transition financing needs.

Introducing a pathway for general purpose sovereign bonds, subject to appropriate safeguards, would allow them to qualify for the Transition and Sustainable categories, rather than being limited to ESG Basics. This would better align SFDR 2.0 with market realities while supporting credible transition objectives.

Another important discussion emerging from SFDR reform concerns ESG data.

Transparency, governance and methodological robustness are essential to sustainable finance markets. Investors increasingly use ESG data to support investment decisions, portfolio construction, risk management and disclosure obligations. 

At the same time, ESG data ecosystems remain highly dynamic and are continuously evolving. he distinction between raw data, estimates, models, analytics, scores and assessments is not always straightforward and methodologies continue to develop alongside corporate disclosure standards and regulatory expectations. 

Extending SFDR to directly regulate ESG data providers could create duplication with existing frameworks, increase compliance costs and introduce legal uncertainty. In practice, these risks slow innovation and reduce the diversity of ESG data solutions available to investors.

Existing initiatives, including the EU ESG Ratings Regulation, are already addressing key transparency and governance challenges in this space. Building on these frameworks, rather than expanding the scope of SFDR, would support a more coherent and effective regulatory approach.

SFDR reform represents a significant opportunity for Europe’s sustainable finance agenda.

Clearer product categories could help  improve transparency, enhance comparability and strengthen investor confidence in sustainability-labelled investment products.

But achieving those goals will require careful calibration to ensure we have an effective framework that supports credible sustainability outcomes, remains globally workable and continues to channel capital toward the sectors and companies driving the real-world transition. This means: 

• Ensuring exclusion criteria are calibrated to preserve investable universes, enabling transition strategies to finance the sectors most critical to decarbonisation.
• Avoiding duplicative regulation of ESG data, building instead on existing frameworks to support transparency without limiting innovation.
• Aiming for interoperability across sustainable finance frameworks, to improve consistency, usability and comparability for investors and market participants.