The upcoming update to the EU’s Sustainable Finance Disclosure Regulation (SFDR) is expected to introduce more detailed sustainability disclosures, revised product labelling and mandatory environmental, social and governance (ESG) reporting, according to regulation and compliance services firm Ocorian. The SFDR, which governs the transparency of sustainability risks and impacts in the financial services sector, is set to undergo amendments that will take effect in 2025. These changes are anticipated to impose stricter and more comprehensive ESG reporting requirements on financial market participants.

In a last week, Ocorian highlighted five key areas where the SFDR is expected to be updated. The first major change involves stronger disclosure requirements. The SFDR update is likely to mandate more detailed information on the sustainability factors considered in investment decisions, as well as on portfolio characteristics related to sustainability objectives. Additionally, the impact of investments on these sustainability objectives is expected to be scrutinised more closely, requiring asset managers to provide more granular data.

Another significant anticipated change is the increased alignment with the EU taxonomy for sustainable activities. The revised SFDR is expected to place greater emphasis on ensuring that products labelled under article 8 (which promotes environmental or social characteristics) and article 9 (which has a sustainable investment objective) demonstrate stronger alignment with the EU taxonomy. This alignment is intended to enhance the credibility and comparability of these products.

The concept of “sustainability risks” is also likely to receive more attention under the new SFDR framework. Ocorian noted that disclosures might need to elaborate on how these risks are integrated into investment processes and risk management frameworks. This would require asset managers to provide more detailed explanations of how they identify, assess and manage sustainability risks within their portfolios.

In addition, the revised regulation is expected to place greater emphasis on principal adverse sustainability impacts (PAIs). The updated SFDR could require more comprehensive disclosures on how investments negatively affect environmental or social goals. Furthermore, reporting on engagement activities with companies concerning these issues may also become mandatory, reflecting the EU’s broader commitment to promoting responsible investment practices.

Another key area of change concerns product labelling. The existing SFDR labels--article 8 and 9--are expected to be revised or supplemented with new categories to provide greater clarity and comparability between different financial products. Ocorian noted that EU and UK regulators are consulting with each other, suggesting that efforts may be underway to harmonise labelling approaches across both regions. This harmonisation could help retail investors better understand a financial product’s focus on sustainability.

In addition to these five areas, Ocorian predicted that the scope of the SFDR might be broadened. While there is no current indication of significant changes regarding who the regulation applies to, the reporting requirements are expected to be expanded. This expansion could mean that even financial market participants who do not promote themselves as ‘sustainable’ might be subject to certain ESG reporting obligations.

Another potential change involves the standardisation of sustainability reporting across all financial products. Ocorian suggested that this could lead to mandatory ESG reporting for all asset managers, regardless of whether their products fall under article 6, 8 or 9. Minimum disclosures for all products would likely include sustainability risks, which would be considered applicable by default and must be reported. Additionally, any sustainability claims made during marketing would require clear justification, ensuring that such claims are substantiated with evidence.

Furthermore, changes to the PAI statements are also on the horizon, following SFDR consultations. If adopted, these changes would introduce new reporting templates for entities required to report under the SFDR. Entities choosing to report PAIs would need to consider and report on a broader range of potential impacts, making the reporting process more comprehensive and detailed.