Commission proposes SFDR changes to simplify disclosures and set product categories

Introduction

The Sustainable Finance Disclosure Regulation (SFDR) was adopted in November 2019 and has applied since March 2021 as a core element of the EU’s sustainable finance framework. Its aim is to increase transparency, combat greenwashing and protect investors by requiring financial market participants to disclose how they consider environmental, social and governance (ESG) factors at both the entity and product levels. Since its inception, the SFDR has shaped a large share of the European funds market, with Article 8 and 9 products accounting for a substantial portion of EU assets under management. However, the European Commission’s (Commission) comprehensive assessment under Article 19 of the SFDR identified material shortcomings. Disclosures are often too long and complex, investor comparability remains limited, and Articles 8 and 9 have been used by the market as de facto labels without clear corresponding criteria. Practical challenges - such as uneven data availability, overlaps with other EU rules, and divergent supervisory interpretations - have contributed to complexity, costs, risks of greenwashing, and inconsistent investor protection across the single market.

Against this backdrop, on 20 November 2025, the Commission published a proposed Regulation (SFDR 2) to simplify the SFDR’s requirements, reduce administrative burdens, improve comparability for investors, and introduce a straightforward, retail‑friendly categorisation for products making ESG‑related claims. The legislative proposal is also designed to align the SFDR with other components of the EU sustainable finance framework, including the Corporate Sustainability Reporting Directive (CSRD), the EU Taxonomy, the EU Climate Benchmarks, and the European Securities and Markets Authority’s guidelines on fund names using ESG or sustainability‑related terms. In line with the Commission’s broader simplification agenda and the Savings and Investments Union strategy, the legislative proposal seeks to rebuild clarity and trust, mitigate greenwashing, and support efficient capital allocation to environmental and social objectives.

Key changes introduced by SFDR 2

The following is a summary of the key changes being introduced by the SFDR 2.

A shift to simple product categories with clear criteria

The most noticeable change is that the SFDR 2 replaces the current Article 8/9 regime with three categories -Transition, ESG Basics, and Sustainable - each underpinned by a 70 percent portfolio threshold, common exclusions, and focused, short‑form disclosures.

Transition products (Article 7) focus on financing the shift of companies, activities or assets towards sustainability. Examples include strategies referencing Climate Transition Benchmark / Paris-aligned benchmarks (CTB/PAB) pathways, investing in issuers with credible transition plans or science‑based targets, and using structured, outcome‑oriented engagement. ESG Basics products (Article 8) focus on integrating sustainability factors beyond pure risk management, such as aiming for ESG outperformance or applying best‑in‑class, but without a transition or sustainability objective. Sustainable products (Article 9) invest in undertakings, activities or assets that are sustainable or that contribute to environmental and/ or social objectives, which may include PAB strategies, EU Taxonomy‑aligned activities, and EU Green Bonds.

Each category features a 70 percent portfolio threshold aligned to the stated strategy; a permitted “deemed compliance” route where Taxonomy‑aligned investments equal or exceed 15 percent (for Transition and Sustainable) or where strategies reference EU Climate Benchmarks; mandatory exclusions calibrated from the EU Climate Benchmarks framework; and succinct templates limited to two pages (plus one page for impact add‑ons where applicable).

In plain terms, the common exclusions are a set of hard stops designed to avoid obvious greenwashing. Investments linked to controversial weapons, tobacco, or companies that seriously breach international norms (UN Global Compact/OECD Guidelines) are out. Exposure to hard coal and lignite is excluded, and the Sustainable category applies tighter fossil‑fuel restrictions than the other two. These exclusions sit on top of the 70 percent alignment test mentioned above, so a product cannot meet the category rules simply by concentrating in a small number of “good” holdings while keeping excluded exposures elsewhere.

The two‑page templates are short, highly standardised summaries that say, in simple language: what the product’s category claim is; how the strategy works; how the product meets the 70 percent threshold; which exclusions apply; the key indicators or targets used to track delivery; and the main sustainability risks. For products with environmental objectives, the template must also state whether, and to what extent, the EU Taxonomy is used to meet the 70 percent threshold. Where a product claims a measurable sustainability impact, a one‑page “impact add‑on” is used to explain the impact objective, the indicators, and progress against them. The same content must also appear on the website in an accessible format, and periodic reports must explain progress against the stated objectives and indicators.

Removal of entity‑level PAI and remuneration disclosures

The draft Regulation deletes entity‑level principal adverse impacts (PAI) reporting and remuneration policy disclosures from the SFDR to streamline and avoid overlap with CSRD. As such Articles 4 and 5 of the SFDR will be repealed. The Commission’s simplification approach instead focuses on product‑level transparency and categorisation, in coherence with the evolving scope of corporate reporting under the CSRD. As such, as the CSRD is implemented, many companies will have to publish standardised sustainability information at the corporate level, so the SFDR, as amended by SFDR 2, removes overlapping firm‑level disclosures and concentrates on what investors need at the product level. The intent is to reduce duplicative burdens and recurring costs, while continuing to require product‑level transparency on sustainability risks and category‑specific elements.

Deletion of the “sustainable investment” definition and DNSH principle

The draft Regulation removes the Article 2(17) definition of “sustainable investment” and replaces the current ‘Do No Significant Harm’ (DNSH) mechanism with category‑specific exclusions and PAI identification at the product level where required. The Commission has removed the definition of “sustainable investment” on the basis that it generated persistent interpretative questions and as such created wide divergence in application leading to supervisory uncertainty across Member States. Firms struggled to operationalise concepts like contribution, “do no significant harm” and good governance in a consistent and comparable way.

In short, the definition was removed because it proved complex, inconsistently applied, and ill‑suited as a market label. In its place the SFDR 2 seeks to embed simplified, objective safeguards directly in the category criteria through binary exclusions (e.g., controversial weapons, tobacco, UNGC/OECD violations, hard coal and lignite, with additional fossil‑related exclusions for Sustainable products). For Transition and Sustainable products, financial market participants must identify and disclose principal adverse impacts at the product level and explain actions taken to address them.

Strict marketing and naming rules tied to categories

Sustainability‑related claims in product names and marketing are to be reserved to categorised products whereas non‑categorised products face strict limits.

Marketing communications must be clear, fair, not misleading, and consistent with the SFDR 2 disclosures. Only products meeting Articles 7, 8, or 9 may use sustainability‑related claims in names and marketing. Non‑categorised products (i.e. those that have not opted into one of the three SFDR 2 product categories) may include limited, ancillary information on sustainability factors in pre‑contractual documents (not in KIIDs/KIDs), provided it is secondary, neutral, and occupies less than 10 percent of the investment strategy section, and they may not use sustainability‑related names. Products that do not themselves qualify but invest in categorised products must disclose the composition and relative shares of those underlying categories and may use sustainability claims in marketing (not in names) if consistent with those disclosures.

Data and estimates governance and investor access upon request

Financial market participants are to formalise and document arrangements for external data (other than public/open sources) and methodologies for in‑house estimates. Upon request, they must provide clients with information on data sources, material assumptions, methodologies, and treatment of missing datapoints. The aim is to improve transparency and investor confidence while acknowledging ongoing data gaps.

Taxonomy and climate benchmarks “deemed compliance” routes

Products replicating or managed in reference to an EU Paris‑aligned benchmark qualify under the Sustainable category; those replicating or referencing an EU Climate Transition Benchmark qualify under the Transition category. In addition, products with at least 15 percent Taxonomy‑aligned investments are deemed to meet the 70 percent contribution condition for Transition and Sustainable, subject to exclusions on the non‑Taxonomy share. The Commission envisages reviewing the 15 percent threshold 36 months after application to align with market evolution.

The term “deemed compliance” means that if a product follows one of three categories, it is treated as having satisfied the category’s core “contribution” test without  separately proving that 70 percent of the portfolio contributes in other ways. The product must still meet the other category rules, including the common exclusions and the short‑form disclosure requirements.

The EU Taxonomy is a set of EU rules that define which economic activities are environmentally sustainable. “Taxonomy‑aligned investments” are holdings that meet those rules. If at least 15 percent of the product is Taxonomy‑aligned, the product can use this as a shortcut to meet the 70 percent contribution condition for Transition and Sustainable. The remainder of the 70 percent can be made up of other qualifying holdings under the category, but any non‑Taxonomy portion must comply with the applicable exclusions. EU Climate Benchmarks are index types with built‑in decarbonisation pathways and exclusions. An EU Climate Transition Benchmark (CTB) is designed to put a portfolio on a transition path that reduces greenhouse‑gas emissions over time. An EU Paris‑aligned Benchmark (PAB) is stricter and aligns with a steeper decarbonisation trajectory. If a product replicates, or is managed by reference to, a CTB, it can qualify for the Transition category; if it replicates, or is managed by reference to, a PAB, it can qualify for the Sustainable category. “Replicating or managed by reference” means the portfolio tracks, or is constrained by, the benchmark’s composition and rules.

These routes are optional. A product can still qualify for a category without using a CTB/PAB or the Taxonomy route, by meeting the general category criteria. In all cases, compliance is checked through the standardised two‑page templates and periodic reporting. 

Streamlined product disclosures and website presentation

Pre‑contractual and periodic disclosures for categorised products are limited to concise templates: two pages for Articles 7, 8 and 9, plus one page for impact‑specific disclosures where relevant. Website disclosures will reproduce the same content, presented in an accessible format. Products pursuing environmental objectives must state whether and to what extent they use the EU Taxonomy to meet the 70 percent threshold which is intended to improve comparability across environmentally‑focused strategies. Periodic reports must explain progress against the stated objectives and indicators.

Next steps

The Commission’s proposed draft Regulation triggers the ordinary legislative procedure. It will be examined by the European Parliament and Council, with trilogue negotiations to follow before a final text can be adopted.

As currently proposed the draft Regulation would enter into force 20 days after publication in the Official Journal and apply 18 months thereafter. However, whilst the draft Regulation does not provide for grandfathering or, save for certain insurance based investment and pension products, transitional relief (nor outright exemption for professionalinvestors only financial products, as initially contemplated) financial market participants will have the option not to apply the draft Regulation to financial products of the closed-ended type which were created and distributed before its entry in force.

The Commission is empowered to adopt delegated acts specifying the category criteria and templates. The existing SFDR Level 2 regulation would be repealed from the application date of SFDR 2.

Based on the legislative timetable and the proposed 18‑month application period, most commentators believe that the earliest possible application could be in 2028, though this depends on the legislative process and the timing of delegated acts.

Practical suggestions for legal and compliance teams

Whilst the draft Regulation has just started its legislative journey there are a couple of steps that in-house legal and compliance teams may wish to take. For example, they may wish to map current product ranges against the proposed categories and assess the feasibility of meeting the 70 percent threshold, exclusions, and indicator‑based measurement for each relevant strategy. They may also wish to review naming and marketing conventions to ensure future alignment with category‑based claims and consider the implications for non‑categorised products. Given the proposed data and estimates regime, teams may wish to think about how they would document data sourcing arrangements and methodologies for in‑house estimates, as well as workflows to respond to client requests. For products with environmental objectives, there is also an evaluation regarding how EU Taxonomy figures could support category compliance and whether CTB/PAB strategies are appropriate. Finally, monitoring the legislative process will be key, the forthcoming delegated acts on category conditions, indicators and templates, and the transitional rules for products in scope, including any opt‑outs for legacy closed‑ended vehicles.