Andrei Geica, chief impact and policy officer at Athens-based circular economy fund manager Sporos Platform, believes the EU’s SFDR legislation should be adapted rather than replaced, notably by reframing the article 8 designation to reduce confusion about its goals and to reduce the risk of greenwashing. But he says the issue of how to assess the sustainability of the start-ups and micro-businesses that dominate the European economy must be addressed.
How would you assess the effectiveness of the Sustainable Finance Disclosure Regulation so far in promoting sustainability goals?
The transparency framework provided by the SFDR remains highly relevant through its sustainability-related disclosure requirements by providing key information to potential investors, especially those that are more environmentally conscious, and by setting clear expectations regarding the investment process for investee companies.
However, I believe a clear and formalised distinction with legal relevance in connection to the EU Taxonomy Regulation exists only for article 9 funds. In our experience at Sporos, while the SFDR is successful at promoting sustainability goals, it does not do a sufficiently good enough job of preventing bad-faith actors from engaging in greenwashing or impact-washing, which ultimately undermines one of the legislation’s principal objectives.
This issue was especially prevalent during the so-called ‘Great Rebranding’ from 2020 to 2022, during which many financial market participants simply added impact-related terms to their products while maintaining their previous modus operandi.
Nevertheless, predominantly through article 9, the SFDR has provided significant credibility and increased accessibility to financial businesses proactively seeking to achieve transformative environmental or social change through the allocation of financial resources, underpinning their investment strategies with the knowledge that this will ultimately also generate value for investors.
How far has the circular economy concept developed within the European fund industry and investors’ sustainability ambitions?
Frankly, not much. To our knowledge, the number of investment funds whose managers actually understand that the circular economy is a systemic approach that goes beyond mere recycling is very limited.
Consequently, those with the necessary team composition and knowledge base to sustain such a mentality shift – focusing on elements such as design, end-of-life and different business models that are inherently circular – are even more rare.
This lack of awareness and thorough understanding is not an industry-specific issue; it is a challenge that exists more broadly among fund sponsors, investee companies, high net worth investors and even institutional investors and banks, compounding the issue of knowledge limitation in relation to the SFDR and EU Taxonomy among critical stakeholders.
For instance, far too often recycling is now branded as circular economy. Although I appreciate the importance of connecting the two, recycling is only a small component required in the transition for our economic system to become a circular one.
Without that knowledge it is very difficult, for example, for a fund manager to structure properly an investment strategy that adequately identifies circular economy opportunities or caters to investee businesses seeking to transition to more circular business practices.
Similarly, it makes it difficult to envision how the entire portfolio can contribute to the transition to a circular economy in a way that amplifies the impact an individual investment can make at a systemic level, or to achieve the potential business benefits of circular practices including cost savings, new revenue streams and higher valuations.
Among investors, especially high net worth individuals, this knowledge can vary, depending on their profile and background. On the positive side, in my experience, once it is explained, the concept is easily understood and valued.
What constraints do the SFDR article 9 regulatory requirements impose in terms of administrative burdens and data collection?
Each organisation’s experience will be different. In large part, it comes down to how prepared they were or are. We are lucky at Sporos that our investment strategy was built from the very beginning to be taxonomy-compliant, even when the EU Taxonomy was still a draft from the High-Level Expert Group on sustainable finance. In other words, we knew what we were getting into.
The administrative and data collection burdens of article 9 are indeed quite high, which makes reliance on external partnerships with the necessary know-how, tools and methodologies crucial.
These partnerships also need to be far-reaching to provide value by tailoring their approach to the needs of the investment strategy and each investee business, rather than just relying on a dashboard. However, this can also be a blessing in disguise, as the data gathered can indicate where avenues for transformation can occur with a minimal impact on operations, and maximum impact on externalities.
If guided by data, focus can be directed towards the overarching impact goal while creating value for companies and for LPs at the moment of exit. Careful consideration of risk needs to be taken, of course, but if properly conducted, the approach can produce win-win-win solutions.
I would say the biggest constraints brought by article 9 are on the use of funds, because the calculation methodologies provided to qualify as a sustainable investment in accordance with one of the EU Taxonomy objectives are very strict and reductive, both for capital expenditure and (especially) operating expenses. There is even a specific section of term-sheet negotiations dedicated to this element – it is imperative (but sometimes very difficult) to convince investee businesses that a certain use of funds we would like to see is to their advantage.
This applies specifically to start-ups and SMEs, which often have a very specific use of funds in mind when seeking capital. Marketing and recruitment generally feature prominently in these business’s plans, especially during the growth stage, but it cannot qualify as a sustainable investment according to the EU Taxonomy.
This may significantly hamper project sourcing or oblige a fund manager to make strategic decisions that will ultimately show a lower proportion of sustainable investment in disclosures within the overall amounts committed. This is not necessarily an issue per se, but it can lead to a situation where the reporting does not accurately reflect reality, making communication with LPs and potential investors more difficult.
This issue will likely become more prevalent with the 80% threshold to take effect for fund names according to the new Esma guidelines. Not only will very few funds be able to meet it, the threshold will ultimately also disincentivise the creation of new article 9 funds, exacerbating the existing problem of article 8 overcrowding and confusion.
Do you believe the current SFDR designations provide sufficient useful information to investors, especially for impact-focused investments?
SFDR categories could certainly be made clearer. On the other hand, there are incurred costs that must be considered when it comes to portfolio building, both in terms of flexibility and excessive constraints. Those expenses could deter some who would otherwise undertake the significant investment strategy reviews required to align with sustainable finance regulation, as well as preclude others from seeking to launch new impact investment funds.
In our experience at Sporos, there remains an acute need for education and awareness-raising among European investors, particularly those in peripheral member states where the SFDR is recognised pretty much in name only, even among institutional investors.
While managers of funds and other investment vehicles may have become very familiar with the detail of the SFDR and the EU Taxonomy, fundraising under their stipulations is still a challenge due to the introduction of unknown variables and greater uncertainty, requiring reassurance and data to provide comfort.
Coming back to our experience, Sporos is currently fundraising for a second closing — but not once have we not had to explain the SFDR, EU Taxonomy, article 9 or the benefits that they can bring. We have slides in our presentations focused specifically on this element, which means we are dedicating valuable time to a task that should not even be part of our function.
It is this experience that makes me believe further changes to the SFDR could be explored. Certainly, there is room for improvement, especially if the legislation is to achieve its pan-European potential for transformation – but only after assessing whether any changes might increase confusion or not, and whether improvement could first be achieved through by awareness-raising campaigns among LP communities that are not limited to Brussels or the capitals of larger member states.
How do you view the options for revising the SFDR suggested by the European Commission, including developing the existing article 8 and 9 categories?
The consultation has demonstrated that the industry is firmly behind the broad objectives of the SFDR, but there is no consensus on how to remedy its gaps and limitations. We are among those who would prefer not to move to a completely new system, but to introduce further specificity within the existing one, predominantly focusing on article 8.
In our view, article 9’s intrinsic link with the EU Taxonomy Regulation provides sufficient clarity and simplicity, including through the combined disclosure requirements. Article 8, though, has become a sort of catch-all for those who do not want to commit to a sustainable investment objective but still seek to pursue a sustainable investment strategy.
This has led to confusion in the market because it has become very difficult to distinguish it from more general ESG investing or even traditional for-profit approaches, whereas article 9 relates more closely to an investment strategy with an evidence-based sustainability objective.
Furthermore, article 8 is the category presenting the greatest risk of greenwashing. It is not by chance that the decline in article 9 funds in 2023 was mostly down to recategorisation to article 8. Of course, this is also part of the market adaptation process, as both GPs and LPs better familiarise themselves with these concepts and the reality of adapting a portfolio to the requirements becomes apparent.
In fact, as manager of an article 9 fund we often find ourselves in competition not with other article 9 funds, but with article 8 funds, especially during fundraising, which obliges us to explain what the differences and added value are.
Even in terms of project sourcing, given that we have more stringent requirements from our investee companies through our Circular Transition Plans, it may be that they view article 8 funds as “good enough”, since they also provide greater flexibility on use of funds when not applying the calculation methodologies of the EU Taxonomy for sustainable investment to one of the objectives.
In conclusion, we favour further development of article 8, improving the communication guidelines for article 9, and the need for a clear labelling system, including a ‘transition’ label – which is already covered for article 9 funds, since the EU Taxonomy introduces the concepts of ‘taxonomy-eligible’ and ‘taxonomy-aligned’, with the need to disclose plans on how to transition from the former to the latter.
The UK has opted for a sustainability labelling regime including transitioning companies and impact investments. Is this a model the EU should seek to emulate?
A labelling regime would certainly help, but replicating what has been designed in the UK for the British market would not have the same impact in the EU. In large part, this is because there isn’t enough distinction across the nomenclature chosen by the UK. Investors, especially retail investors and those pivoting toward sustainable investing for the first time, will struggle to understand clearly the difference between sustainability improvers, sustainability focus, sustainability impact and sustainability mixed goals.
Although these categories were tested in the UK using consumer research and stakeholder engagement, the issue comes down to the conditions under which these exercises took place. The same experience in a less mature market would not yield the same benefits for the EU that the UK hopes to see in its jurisdiction.
In my view, considering that the SFDR is already used by the industry as a de facto labelling system, a nomenclature that improves on the current one based on the legislation’s articles, in tandem with a reframing of article 8, is the way to go. Under such conditions a labelling regime could contribute significantly to improving awareness among LPs and the European investor base, without adding further burdens or restrictions on fund managers.
Will the EU’s Corporate Sustainability Reporting Directive offer the breakthrough needed in terms of filling out the data gaps in SFDR compliance?
We definitely view the CSRD and SFDR as complementary pieces of legislation that seek to improve transparency and accountability on ESG. However, I would not call the CSRD (or its relationship with the SFDR) a breakthrough because it only solves part of the sustainability data challenge posed by the SFDR, predominantly due to its scope — especially regarding SMEs.
We keep hearing that SMEs form the backbone of the European economy. Considering that 99.8% of all active businesses in Europe are SMEs, it’s hard to disagree. But the vast majority of those entities are micro-enterprises with fewer than nine employees and do not have the capacity to meet the regulatory and cost requirements to become listed, and so fall outside the CSRD’s scope.
This means the key challenge under the CSRD is for funds that invest in start-ups and SMEs, especially since there can be no discussion about transition to a circular economy unless the predominant components of that economy are targeted. Either fund investment is constricted, or the fund must reach a minimum variable size to possess the resources needed to engage in the types of partnership necessary for data collection to comply with the SFDR.
The key advantage from the conjunction between the SFDR and CSRD is that when a sustainable start-up receives investment from an SFDR-compliant fund, it typically develops systems to collect and report relevant ESG data. If the start-up is later acquired by a larger business subject to CSRD reporting, the acquired company’s existing ESG data and reporting systems become valuable for the acquirer’s CSRD compliance and potentially reduce the cost and complexity of its own CSRD reporting.
Similarly, when an unlisted small business in a larger group’s value chain has robust ESG data, perhaps as a result of SFDR-compliant investment, this data can contribute to the larger company’s value chain reporting under the CSRD.
This synergy creates additional value for funds that invest in sustainable start-ups and SMEs. It makes their portfolio companies more attractive acquisition targets and may potentially increase their valuations. In our view, this advantage should be priced in during sale negotiations and represents a key added value of funds that invest in sustainable businesses.
Should the EU seek to align its sustainability definition, labelling and reporting rules with those in other jurisdictions, or set out a global model for others to follow?
The EU had one ambitious, overarching goal with the Green Deal: to become a world leader in the green transition. The Green Deal was not portrayed simply as a policy to combat climate change, but as an industrial and a competition policy. Following the European Parliament elections, this still seems to remain the case among member state governments, which is great news. Meanwhile, a second Von der Leyen term at the Commission will guarantee at least a certain degree of continuity in this prioritisation.
At the end of the day, this is a binary choice. If things continue as they are, it will lead to increasing loss of value at all levels due to the effects of climate change, with scientific consensus underlining devastating and unpredictable effects. Alternatively, where sustainability becomes a necessary condition in the economy, those who transition first will have a competitive advantage, especially amid a rapidly shifting geopolitical landscape.
This same dichotomy also applies to the financial framework. If the EU takes the transition to net zero by 2050 seriously, it will be an opportunity for Europe truly to become the global leader in this transformation.
This shift in focus, however, must also be applied to its financial industry, which would benefit from a competitive advantage over other jurisdictions. The UK’s labelling system was based on lessons learned from experience with the SFDR, which is precisely the type of transformational influence and competition impetus that we want to see from EU legislation. The net result is a faster transition towards a more sustainable economy at global level and a better future for us all.
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Andrei Geica is the Founder and Partner responsible for Impact and EU Public Policy at Sporos Platform, the first Impact Investment Fund focused on the Circular Economy in South-East Europe. Leveraging his extensive experience from the European Parliament and his role as a policy monitoring consultant in one of Brussels’ largest Parliamentary legislative monitoring consultancies, Andrei has brought his expertise to the financial sector in the underserved South-East European region by providing tailored policy monitoring in Greece. His deep understanding of the policy process and global financial trends, coupled with his expertise in Circular Economy and Climate Resilience, led to the creation of the Sporos Platform, which not only drives impact investments but also fosters sustainable financial growth in the region.
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