Exploring the Essence of the EU Sustainable Finance Disclosure Regulation: Defining Sustainability by What it is or What it is Not?

Abstract

Mutual funds can contribute to achieving sustainable objectives. The introduction of the European Union's Sustainable Finance Disclosure Regulation (SFDR) requires funds to classify themselves as disclosing at pre-specified sustainability transparency levels. Since the implementation of the regulation, there has been a tension between two perspectives on how financial market participants view and utilise the SFDR, stemming from the question of how to define sustainability. In the first view, sustainability in the SFDR is defined by 'what it is', i.e. doing good (e.g. renewable energy). In the second view, sustainability is defined by 'what it is not', specifically by avoiding adverse impacts. This study explores the tension between both views by examining the determinants of SFDR self-classification based on a fund's signature features and sustainability strategies, related to both views for European equity and fixed income funds. We find that the sustainability strategies, in particular, provide support for the view that the SFDR is defined by 'what it is not'. The foremost reason that fund managers classify their funds as sustainable is related to the type of sustainable strategies they employ; specifically, the basic exclusion strategy, where fund managers apply negative screens to exclude companies or sectors and to avoid their adverse impacts. Supporting evidence for the alternative view is limited to some fund managers employing more nuanced strategies like engagement to classify their funds highest on sustainability. Notably, only funds employing the exclusion strategy consistently have better sustainability outcomes, suggesting that funds employing supposedly more sophisticated strategies run the risk of not delivering on their sustainability commitments. Our findings highlight that definitions and standards for sustainable investing warrant further investigation and monitoring to ensure that investors contribute to achieving sustainability objectives.

Keywords: Sustainable Finance Disclosure Regulation, Sustainable investing, Sustainable Finance Disclosure Regulation, Sustainable investing, Sustainability fund ratings

JEL Classification: G2, G23, G28