SFDR: A greentech VC rollercoaster — three years in and what’s next?

Insights, challenges, and bold recommendations for sustainable finance in Europe

The world is grappling with unprecedented environmental and social challenges, and ambitious founders are pivotal in creating the breakthrough solutions we need to solve them. As an early-stage VC, our mission is to support these innovators and amplify their impact on a larger scale.

Making sure that funding is going where it will have the greatest positive impact remains a challenge.

The European Union’s Sustainable Finance Disclosure Regulation (SFDR) set out with highly ambitious goals three years ago — not only to prevent fund “greenwashing” but also to redirect capital to support the EU’s “Green Deal” and achieve carbon neutrality by 2050.

Let us start with expressing a resounding commendation for the EU’s bold move in adopting the SFDR, which marked a pivotal shift in prioritising sustainability in finance. This was a hugely important step.

But how successful has it been? And how would it be even better positioned to fulfil its purpose? Here, we share our perspectives as an early-stage VC and come up with recommendations alongside 50 other impact investors to ensure it delivers on its promise.

BY THE NUMBERS

There are different views on how successful the regulation has been so far: An analysis by Goldman Sachs in 2023 found that managers find it increasingly difficult to market Article 6 funds. Some 231 funds upgraded their classification in the fourth quarter of 2023 alone, mostly from Article 6 (funds without a sustainability scope) to Article 8 (promoting environmental and social objectives). During the same period, just 25 funds reclassified downwards (KPMG 2024).

But does that mean that there has been a massive reallocation of capital in line with SFDR’s important policy objectives?

• Although Article 8 funds now account for 55% of European fund assets 50% of these still hold investments in oil&gas;
• Funds with distinct sustainability objectives and a Do-No-Harm approach (Article 9) account for not even 4%.

Observers tend to agree that the increase of Article 8 fund assets does not seem to have driven a massive shift in corporate activity to meet the EU’s environmental and social sustainability goals (FT). The German financial supervisory authority BAFIN comes to the conclusion:

“In general, the impact of European sustainability regulation on financial flows into sustainable investments has so far been relatively limited. This is indicated by market data.”

Our own journey with the SFDR has been nothing short of a rollercoaster. From grappling with compliance headaches to uncovering opportunities, we’ve learned a lot. Here we highlight our own experience, key insights from the latest consultation, and some recommendations for the future.

OUR EXPERIENCE

We embraced the Sustainable Finance Disclosure Regulation (“SFDR”) from day one. It has the potential to:

• Direct funding towards sustainable investment products, including greentech venture capital and private equity.
• Reduce greenwashing and ensure funding goes to truly sustainable investors.

We were the first German SFDR Article 9 fund (“dark green”), meaning that all of our investments have a sustainable objective.

What we found is that the SFDR aims high, but it’s missing the mark in key areas:

• Many cutting-edge clean technologies are left out of the EU Taxonomy.
• The lack of clear, consistent guidance across EU member states turns compliance into a guessing game, distorting the competitive landscape for funds operating in multiple countries.
• What is more, SFDR was designed with larger funds investing in listed assets in mind. As a result, it is ill-suited for the reporting of impact funds, especially those dedicated to investments in small- to medium-sized, unlisted and illiquid companies, often at their early stages of development.
• For greentech VCs, the SFDR feels like a square peg in a round hole. The focus is on past performance metrics like greenhouse gas (GHG) intensity instead of forward-looking potential. This means it is not geared towards innovative startups poised to make big strides in emissions reduction.

EU SOUL SEARCHING: SFDR 2.0

Very sensibly, the EU has done some soul searching lately and initiated a review. They wanted to determine “if our rules meet their needs and expectations, and if it is fit for purpose.” As a possible way forward the Commission was proposing to either develop the distinction between article 8 and article 9 further.

Or, create a 4-category system focusing on investment strategies:

1) IMPACT: Products investing in assets that specifically strive to offer targeted, measurable solutions to sustainability-related problems that affect people and/or the planet (e.g. investments in firms generating and distributing renewable energy, or in companies building social housing or regenerating urban areas;

2) SUSTAINABILITY: Products aiming to meet credible sustainability standards or adhering to a specific sustainability-related theme (e.g. investments in companies with evidence of solid waste and water management, or strong representation of women in decision-making);

3) EXCLUSION: Products that exclude activities and/or investees involved in activities with negative effects on people and/or the planet (e.g. fossil fuels, gambling, controversial weapons, etc.);

4) TRANSITION: Products with a transition focus aiming to bring measurable improvements to the sustainability profile of the assets they invest in (e.g. investments in companies, economic activities or portfolios with credible targets and/or plans to decarbonise, improve workers’ rights, reduce environmental impacts.

SFDR: THE MARKET HAS VOTED

The results of the Commission’s consultation pulled no punches.

Respondents slammed the SFDR for its high compliance costs, murky definitions, and unhelpful disclosure requirements. A staggering 98% struggled with data quality, while many decried the regulation’s evolution into a marketing tool rather than a straightforward disclosure mechanism. Key points raised:

• 52% of respondents to the commission’s consultation did not agree that the SFDR “has successfully directed capital towards investments deemed sustainable, including transitional investments”;
• 77% of respondents also highlighted key limitations of the framework such as “lack of legal clarity regarding key concepts, limited relevance of certain disclosure requirements and issues linked to data availability”;
• 84% felt “that the disclosures required by the SFDR are not sufficiently useful to investors”;
• 58% did not feel the costs “to be proportional to the benefits generated”;
• 82% felt “that some of its requirements and concepts, such as ‘sustainable investment’ are not sufficiently clear”.

Interestingly, respondents showed no clear preference on whether to split the categories in a different way than Articles 8 and 9 or to convert them into formal product categories by clarifying and adding criteria to the underlying concepts. The German financial authority calls for cutting the reporting requirements around the “Principal Adverse Impact” indicators by two-thirds and installing three distinct categories.

It looks like everyone agrees the regime doesn’t work yet, but we cannot agree how to fix it.

WHAT THE EU SUPERVISORY AUTHORITY SAY

Last month the European Supervisory Authorities (ESAs) acting on their own initiative, published a Joint Opinion on the assessment of the SFDR. They proposed a streamlined product classification with clear, objective criteria and/ or a sustainability indicator to help investors navigate the market (think of it as the Nutri-Score for finance — simple, intuitive, and effective).

The ESAs also urged for a more prescriptive definition of “sustainable investment” to eliminate market inconsistencies and suggested expanding the SFDR’s scope to cover currently exempt products. Their call for tailored disclosures for retail versus sophisticated investors is a nod to the diverse needs across the investor spectrum.

But how do impact funds view the SFDR?

IMPACT FUNDS AND THE SFDR

A recent survey by Impact Europe “Experience of Impact Funds with SFDR” pointed out that the regulation was designed for larger, listed asset funds — the regulation doesn’t fit the unique needs of smaller, early-stage enterprises and those in emerging markets. The broad, indistinct definitions between sustainable and impact investments foster greenwashing risks and unfair competition.

Impact investors were pushing for an “Article 9 plus” category, which would include binding impact targets and robust impact measurement criteria. This would finally give impact funds the recognition and competitive edge they deserve.

We can relate to that demand.

WHAT WE ARE CALLING FOR

Early stage VC is where the bets are made on founders with the big ideas and new ways of thinking to deliver true systemic change and an economy within the planetary boundaries.

To channel more capital into these solutions, we need to differentiate between general sustainable investment strategies and those designed to achieve positive social or environmental impacts. Impact investments, defined by the Global Impact Investing Network (GIIN), are investments made with the intention to generate positive, measurable social and/or environmental impact alongside financial returns.

We thus support the European Commission’s proposal for a four-category system, including a new category targeting investments that strive to offer measurable solutions for the huge social and environmental challenges we are facing. This system should include clear and relevant disclosures for impact-positive assets.

This way we enable impact funds to distinguish themselves from ESG and sustainable products, based on binding investment strategy and organisational framework criteria (such as pre-defined intentionality, binding impact targets, impact measurement and management, reporting, impact-linked carried interest, etc.).

The focus should be on forward-looking indicators, i.e. the impact potential of investments. This in turn requires us to agree on how to substantiate claims of positive environmental or social contribution in the industry. We at Planet A, as a science-driven greentech fund, calculate life-cycle-assessments to quantify the positive impact of a startup`s innovation prior to an investment. We stand ready to contribute to developing common criteria.

What more could we wish for?

• Establish a strong but simple transparency system for ALL financial products on the market, which would ensure an important level of basic comparability. It seems out-dated and odd that only those who want to do better need to report on their contribution. We need transparency on capital flows and whether they contribute to a more sustainable economy or not.
• Update the EU Taxonomy to include more green technologies. A bunch of innovative technologies mission-critical to achieve net-zero is not yet comprehensively covered. This includes for instance energy storage technologies, particularly advanced battery technologies, thermal storage, and innovative grid storage solutions; production of green hydrogen; circular economy solutions such as innovations in material recycling, upcycling, and waste-to-energy processes, or Carbon Dioxide Removal (CDR) technologies.
• And last but not least: Introduce an element of proportionality when considering underlying investments within financial products, e.g. when the investee company is an unlisted SME. In other words: ease the reporting burden on young startups.

We are seeking to further amplify these experiences and conclusions and have recently issued a joint statement together with over 50 other funds in the “United for Impact”-Initiative, as well as drafted reform proposals with the Cleantech for Europe initiative last year — please stay tuned, a new joint position paper will be released soon!

Author: Lena Thiede, Co-Founder & General Partner at Planet A