The Sustainable Finance Disclosure Regulation (SFDR) aims to increase transparency, protect consumers, and direct capital toward activities that support the European Green Deal. To reach its goals, the disclosure requirements need to align with investors’ needs. So far, the regulation has neither fully protected investors from misleading claims nor successfully channeled their capital into products that achieve real-world change.
A new policy briefing published by the think tank Sustainable Finance Observatory addresses this gap and contains four key recommendations for regulatory changes. In a prior blog post, I argued with colleagues that the current SFDR misses out on making real impact. The briefing makes four key recommendations to fix these shortcomings in the forthcoming SFDR review:
- Redefine product categories. The SFDR’s current categories are often misunderstood and misused. The briefing proposes a new categorization based on the sustainability strategy of a product. Financial products should be classified by whether they pursue value alignment, investments that match investors’ ethical principles, such as excluding coal or tobacco, and/or impact generation, where the explicit goal is to create measurable change in the real world, for example by engaging with companies to shift their practices or providing capital to underserved but impactful firms. Defining sustainability objectives in this way would give investors clarity and ensure products match their true intentions.
- Introduce a legal definition of impact-generating products. Today, the SFDR focuses on the sustainability of underlying company activities but says little about whether an investor’s money makes a difference. The briefing calls for a clear definition of impact-generating products in EU law: products that have a strategy to contribute to positive real-world outcomes in addition to delivering financial returns. Such a definition would have to be accompanied by disclosure requirements and minimum criteria. It would also help investors distinguish between “company impact” (what businesses do) and “investor impact” (the change caused by investors).
- Set minimum criteria and disclosure rules for impact. Not all impact claims are credible. To safeguard consumers, impact-generating products should be subject to additional requirements. These should cover the accepted principles of impact investing: intentionality (a clear goal to generate change), measurability (robust methods to assess results), impact management (a credible strategy for achieving outcomes), and reporting (transparent communication of progress). The briefing suggests mandating an expert group or the Joint Research Centre to develop technical standards. This would ensure that impact claims are substantiated and prevent the kind of “impact-washing” that currently undermines trust.
- Align investment advice with sustainability objectives. Under MiFID (Markets in Financial Instruments Directive) and IDD (Insurance Distribution Directive), advisors must already assess client preferences for sustainability. However, because “sustainability-related objectives” are not defined, many advisors fail to capture whether a client seeks value alignment or impact generation. The briefing proposes amending suitability assessments to explicitly recognize these two types of objectives. This would reduce the risk of mis-selling, ensure investors are offered products that truly match their preferences, and unlock latent demand for impact products that is currently unmet.
Why investor impact matters
Implementing these recommendations could help the SFDR correct a severe imbalance between investor intent and real options available. The SF Observatory show that 51 percent of retail investors are impact-oriented with their money, but impact-generating products represent only around one percent of the market in key countries, such as Germany and Austria. Moreover, mystery shopping exercises reveal that many impact-oriented investors are routinely misadvised, and a review of existing funds found that more than a quarter make misleading environmental impact claims.
My own research, published in The Review of Financial Studies, shows that while investors care deeply about impact, they are often insensitive to its magnitude. Many are motivated by emotional satisfaction. They value the “warm glow” of choosing a sustainable option, regardless of whether the product delivers genuine change. This creates incentives for financial institutions to market products that feel impactful rather than those that actually are. To correct this, regulation must ensure that the products investors are drawn to also deliver real-world outcomes.
Especially valuable is the distinction between investor and company impact, which partly draws from my research summarized in The Investor’s Guide to Impact, written together with Julian Kölbel. Investors can have an effect by enabling impactful companies to grow or by encouraging other firms to improve. Recognizing these mechanisms and embedding them into regulation is essential if we want sustainable finance to go beyond labels and contribute meaningfully to societal goals.
A pragmatic path forward
The Sustainable Finance Observatory’s policy briefing offers a pragmatic and evidence-based way forward. If implemented, these reforms would not only protect investors from misleading claims but also unlock the vast, currently untapped demand for impact-oriented products, turning sustainable finance into a more powerful lever for the transition towards a net-zero economy.
Florian Heeb is Assistant Professor of Sustainable Finance at SAFE.
Blog entries represent the authors’ personal opinion and do not necessarily reflect the views of the Leibniz Institute for Financial Research SAFE or its staff.
