SFDR Unpacked: What to Look for in Article 8 and 9 Portfolios

European investors are struggling to understand new rules designed to confirm the environmental, social and governance (ESG) credentials of portfolios. Since regulatory guidelines are vague, asset managers must provide a clear framework to show how their products fit sustainable investing classifications.

The EU’s Sustainable Finance Disclosure Regulation (SFDR) aims to improve transparency about the ESG features of investment portfolios by having firms classify them as Article 8 or Article 9 products. However, definitions of Article 8 and 9 are quite broad. When SFDR’s level 2 requirements take effect in January 2023, firms will need to provide more details explaining portfolio alignment with these categories. To decipher the disclosures, investors should focus on three issues: how ESG research is integrated in investment processes, what applicable engagement activity is conducted with issuers and whether a clear methodology is applied to classify portfolios.

Integrated ESG Research Paints a Complete Picture

Under SFDR, Article 8 portfolios should promote, “environmental or social characteristics, or a combination of those characteristics, provided that the companies in which the investments are made follow good governance practices.” But what does this really mean?

We believe investors must integrate ESG issues in fundamental research to assess company behavior and risk/return potential. Fundamental analysts, who are immersed in a company’s business and financials, can best judge how ESG issues affect the outlook, and how a company is (or isn’t) evolving to promote positive change.

What threats does a company face from climate change? Does corporate culture support innovation and growth? Is the board truly diverse? Analysts who are familiar with a company can ask the right questions and draw the most meaningful ESG conclusions.