EU confirms overhaul of SFDR rules with implications for real estate funds

The European Commission has announced a widely anticipated overhaul of the EU’s Sustainable Finance Disclosure Regulation (SFDR) with major implications for the management of institutional real estate funds.

The Commission has proposed the abolition of Article 8 and 9 sustainability labels – which had proved difficult for real estate funds – while also creating new simplified classifications and stricter disclosures.

The changes, leaked earlier this month, aim to address persistent criticisms around the complexity and ambiguity of the current rules. One of the leaked proposals – allowing alternative funds for institutional investors to “opt out” of SFDR entirely – was not included in today’s announcement.

Arguably of most importance is the confirmation that Article 8 and Article 9 classification labels will be replaced by three new product categories: “sustainable”, “transition” and “ESG basics”.

The transition category, aimed at investments in companies or projects “that are not yet sustainable, but that are on a credible transition path” will be useful for real estate funds that seek to improve the sustainability of existing buildings, such as through retrofits and measures that increase energy efficiency.

The sustainable category applies to “products contributing to sustainability goals… such as investments in companies or projects that are already meeting high sustainability standards”, while ESG basics is for “products that integrate a variety of ESG investment approaches but do not meet the criteria of the above-mentioned sustainable or transition investment categories”.

Jeff Rupp, director of public affairs at European real estate investment association INREV, said: “The introduction of a transition category will attract investment into real estate, which as a long-term asset must generally be retrofitted to become more sustainable. Reporting under SFDR is currently unhelpful because most transition strategies fall under Article 8, which is overly broad and does not reward transition progress.”

Melville Rodrigues, head of real estate advisory at Apex, said: “It is very welcomed that the Commission is proposing categories (as a replacement of disclosure labels) – in particular, a transition category. This proposal will hopefully be implemented into legislation, and enhance the prospects of much needed pension fund and other institutional capital supporting real fund manager sustainability strategies.”

In announcing the new proposed category framework, the Commission noted that SFDR had “effectively been used as a de facto labelling system, causing confusion – particularly for retail investors – and increasing the risk of greenwashing and mis-selling”.

The proposals also include the removal of the principal adverse impacts (PAI) regime, so that asset managers and advisers will no longer have to disclose how investment decisions adversely affect sustainability factors.

“The revised SFDR proposal is a significant and welcome step forward,” said Rupp. “We’re pleased to see that the European Commission has listened to, and taken account of, several recommendations we suggested.

“The decision to adopt clear categories and to remove the PAI disclosure requirement at the entity level, is hugely significant and positive for our industry. We also welcome the formal recognition of transitional strategies, the shift of emphasis to a product regime and the Commission’s focus on reducing reporting costs.”

A 12‑month transition period is expected during which existing Article 8 and 9 funds will have to migrate into the new categories or adjust their positioning.

“There is still detail to be worked out – notably around the regulatory technical standards and managing the transition to the new regime. But if implemented effectively, these changes could drive real progress in unlocking capital for sustainable investment in the non-listed real estate market.”

Hugo Llewelyn, CEO of Newcore Capital, welcomed the proposed changes to SFDR due to “the increasing political rhetoric against sustainability as a whole, using greenwashing examples to throw the baby out with the bathwater”.

He said: “Adapting and updating the rules of SFDR is therefore inevitable and important – firstly, to keep pace with the regulators’ role protecting investors against mis-marketing by unscrupulous managers, and secondly to provide a level, relevant playing field for managers and funds genuinely motivated by sustainability.”