The European Commission’s proposal to revise the Sustainable Finance Disclosure Regulation (SFDR) responds to growing confusion around fund classifications and greenwashing concerns by shifting from a disclosure focused regime to a clearer, more investor friendly product categorisation framework.

Done well, SFDR 2.0 could clarify product intent, improve comparability, and support more effective capital allocation towards sustainability and transition outcomes; done poorly, it could increase costs, narrow investable universes, and undermine confidence in sustainability focused products. 

The proposal gets many fundamentals right, but targeted refinements are needed to ensure it works in practice. PGIM is actively engaged in the policymaking process, working through our trade associations and meeting directly with policymakers and regulators. The following are some of the improvements we are seeking to advance in discussions in Brussels.
 

A WELCOME SHIFT

The most important improvement in SFDR 2.0 is the shift towards a formal product categorisation system aligned with product design and intent. This has the potential to reduce reliance on marketing interpretation, set clearer expectations around sustainability objectives and improve comparability across products.

Equally important is the simplification of disclosures. Shorter templates, reduced website reporting and the removal of entity level Principal Adverse Impact reporting should reduce noise and refocus attention on what matters most to investors: the strategy, the sustainability objective and how progress is measured.
 

KEEPING THE FOCUS

SFDR was designed primarily with retail investors in mind, and that focus should be preserved. For professional investors, including pension funds and insurers, sustainability requirements are often bespoke and embedded in tailored investment solutions. Applying rigid standardised categories and disclosures to solutions offered to professional investors risks reducing flexibility without improving investor protection. Therefore, the proposal rightly removes portfolio management and investment advice from scope. The same logic should apply to investment products marketed to professional investors. Allowing products marketed exclusively to professional investors to opt out of SFDR categorisation would preserve flexibility while keeping the framework centred on retail comparability.
 

MAKING THRESHOLDS WORK

Quantitative thresholds, particularly the requirement that at least 70% of assets meet sustainability criteria, are central to SFDR 2.0. The recognition of ramp up periods for new funds is welcome, but portfolios are dynamic. Market movements, rebalancing and flows can all lead to temporary deviations.

If thresholds are applied too rigidly, they risk creating cliff edge effects, forcing unnecessary trading or triggering reclassification for short term reasons unrelated to long term objectives. A more pragmatic approach would allow temporary deviations where these are transparently disclosed, actively managed and clearly linked to an intention to restore alignment. This flexibility is especially important for less liquid strategies and closed ended funds approaching wind down.
 

THE NEED FOR CLARITY

For fund-of-funds and mixed assets portfolios, clarity on threshold calculation is essential. Liquidity characteristics of investment products are paramount in determining an appropriate approach. For example, a look-through approach would create operational complexity and lead to unnecessary costs where the underlying funds are invested in liquid assets with high turnover but would be a good solution where the underlying funds are less liquid and therefore have more static portfolios. For liquid strategies, ensuring that each fund within a fund-of-funds is 70% aligned with at least one category would be the most efficient approach. For mixed asset portfolios, direct holdings that clearly meet sustainability criteria should be treated consistently with investments in categorised fund.
 

PORTFOLIO LEVEL TARGETS MATTER

Many credible sustainability and transition strategies are managed against portfolio level objectives such as emissions intensity reduction, temperature alignment or thematic exposure, rather than rigid asset by asset rules. While the proposal allows portfolio level targets for transition strategies, it is silent on their use elsewhere.

Explicitly allowing portfolio level targets for Sustainable and ESG Basics products would better reflect how strategies are implemented and assessed in practice. Portfolio level metrics often provide a clearer and more decision useful view of outcomes than asset-specific thresholds.
 

EXCLUSIONS: AVOIDING UNINTENDED CONSEQUENCES

Minimum exclusions help set baseline expectations but expanding exclusions beyond existing Paris Aligned and Climate Transition Benchmark standards risks shrinking investable universes without improving real world outcomes. This is particularly problematic for transition critical sectors and emerging markets, where capital is most needed.

Excluding companies such as BHP Group or Pacific Gas and Electric Company (PG&E)  illustrates the risk. Both face exclusion under proposed rules despite credible transition pathways, strong emissions reduction plans and substantial investment in decarbonisation. Transition is rarely linear. Temporary expansion of fossil-fuel related activities that enable system wide emissions reduction can be part of a credible pathway. A framework that cannot distinguish between structural expansion and transitional steps risks penalising transition leaders and discouraging progress.
 

RECOGNISING THE ROLE OF PUBLIC ENTITY BONDS

Public entity bonds are central to fixed income portfolios and critical to financing decarbonisation and sustainable development. Restricting general purpose sovereign bonds to ESG Basics category underestimates their role. While no single universal methodology exists, credible sovereign sustainability frameworks already assess transition pathways, emissions trajectories and policy alignment and can credibly distinguish transition and sustainability leaders among sovereign issuers.

The examples of Romania, France and Costa Rica illustrate this point. Using a consistent assessment methodology, all three countries demonstrate credible climate performance or transition trajectories, despite differing economic structures and development stages. Romania and France show alignment with a ~2°C pathway, driven by relatively moderate emissions intensity and sustained recent reductions, potentially supporting their inclusion within Transition strategies even where structural challenges remain. Costa Rica represents a more advanced case, with very low emissions, near 100% renewable power, and Paris aligned policies, making it a strong candidate not only for Transition but arguably Sustainable strategies.
 

RETHINKING PRINCIPAL ADVERSE IMPACT DISCLOSURES

Mandatory product level PAI disclosures for Transition and Sustainable products risk perpetuating one of SFDR’s core weaknesses: high reporting burden with limited investor benefit. In practice, PAIs often add technical complexity rather than clarity and cause confusion for investors.

The proposal is also unclear on whether PAIs must be drawn from a fixed list or tailored to strategy. A mandated list risks misalignment with product objectives, while bespoke KPIs make mandatory PAIs largely redundant. These issues are compounded by data gaps, ongoing uncertainty in corporate disclosures and estimation costs.

A more pragmatic approach would remove mandatory product level PAIs for Transition and Sustainable products and instead introduce a simplified voluntary list to support consistency in reporting for products that use certain PAIs as their sustainability KPIs.
 

IN THE DETAILS

Several technical design choices will determine whether SFDR 2.0 works in practice:

• Use of proceeds bonds are a key tool for financing sustainability and transition and should be treated consistently across categories, supported by robust assessment methodologies.
• Derivatives and short positions, widely used for risk management, require clear guidance on how they are treated for eligibility thresholds and categorisation to avoid inconsistent interpretations.
• Pragmatic treatment of “Paris alignment” is essential. Overly rigid or ambiguous references risk excluding credible transition strategies and reducing incentives for real-world climate mitigation. A focus on transition leaders identified via robust, evidence based transition assessments would be more pragmatic and credible.
• Clearer boundaries are needed around disclosure constraints for non-categorised (Article 6a) products. Disclosures on the integration of financially material sustainability factors and stewardship should remain permissible, with any constraints applying only to sustainability claims that go beyond financial materiality.
   

A FRAMEWORK WORTH GETTING RIGHT

With targeted refinements, SFDR 2.0 can help direct capital towards sustainability and transition in a way that reflects economic reality, supports long term returns, and delivers meaningful outcomes. The cost of implementation will be significant, but it will be worth it if the details are right. The proposed shift towards clearer categories, simpler disclosures and greater alignment with market practice is a strong foundation. SFDR 2.0 has the potential to restore confidence in Europe’s sustainable finance framework.