Legal development

SFDR Level 1 Revision – Proposal by the European Commission

By Lorraine Johnston, Henry Glasford and Marc Hirtz

28 November 2025

I. Executive summary

On 20 November 2025, the European Commission proposed a comprehensive revision of the SFDR which intends to simplify disclosures and improve comparability for investors whilst reducing recurring compliance costs (SFDR II). If implemented as drafted, the market should expect a period of recalibration.

The proposal – which deviates in a number of aspects from the recently leaked draft – replaces the current Article 8/9 construct by three new claims-based product categories:

ESG Basics;
Transition; and
Sustainable;

each anchored to a common 70% alignment threshold and calibrated exclusions. This threshold is sufficiently high enough to deter superficial claims, yet addresses some of the previous concerns under SFDR I specific to certain asset classes. The proposal also introduces an “impact” designation for products with intentional, measurable environmental or social outcomes. In addition, entity-level PAI reporting is repealed, whereas naming and marketing rules are clarified.

The Commission is empowered to adopt implementing measures specifying conditions, indicators, calculation methodologies, and disclosure templates.

The leaked text indicated the possibility of an exemption for professional-only AIFs. This has not materialized and professional-only AIFs will be subject to SFDR II.

II. Context and policy objectives

The SFDR has driven widespread market adoption of ESG-labelled products but revealed shortcomings: complex templates, divergent interpretations, data gaps, and the quasi-labelling of Articles 8 and 9.

The review is an implicit acknowledgement that the original SFDR led to ambiguity and undesirable outcomes for the industry.

Now, SFDR II targets two objectives:

First, to simplify disclosures, lower costs and improve operational coherence across the sustainable finance framework, including alignment with CSRD simplifications.
Second, to protect investors by establishing a claims-based product categorisation that improves clarity, comparability and enforcement against misleading ESG claims, while deepening the single market for sustainability-linked products.

III. Scope and structural changes

SFDR II refocuses the regime on financial market participants that manufacture, manage or make available financial products. Financial advisers and portfolio managers are removed from scope.

The definition of “sustainable investment” is deleted to resolve interpretative inconsistencies in its underlying concepts which are now embedded directly in category criteria.

Additionally, financial market participants are no longer required to disclose entity-level PAIs and the integration of sustainability risks in remuneration policies.

IV. Categories and core criteria

All financial products (including non-categorised products, please see item VI. below) remain subject to disclosures as regards how they integrate sustainability risks in the investment decision process (when relevant) and the results of the assessments of the likely impacts of sustainability risks on the returns of the product.

The proposal introduces a new categorisation regime with three categories corresponding to the nature and ambition of the sustainability claim. Each category requires a minimum 70% share of investments that comply with the stated objective or strategy, measured using appropriate indicators. The proposal framework also introduces common exclusions.

ESG Basics (Article 8)

Claim/Objective	Integration of sustainability factors beyond the consideration of sustainability risks.
Minimum alignment	70% in investments integrating sustainability factors.
Exclusions	companies involved in any activities related to controversial weapons; companies involved in the cultivation and production of tobacco; companies that benchmark administrators find in violation of the United Nations Global Compact (UNGC) principles or the Organisation for Economic Cooperation and Development (OECD) Guidelines for Multinational Enterprises; and companies that derive 1 % or more of their revenues from exploration, mining, extraction, distribution or refining of hard coal and lignite.
PAIs	N/A
Alternative	N/A
Eligible assets	investments with an ESG rating which outperforms the average rating of the investment universe or the reference benchmark; investments which outperform the average investment universe or reference benchmark on a specific appropriate sustainability indicator; investments which favour undertakings or economic activities with a proven positive track record related to sustainability factors; combination of investments pursuant to Articles 7(2) or 9(2) with the foregoing investments; other investments integrating sustainability factors with proposer justification.
Impact "label"	No

Transition (Article 7)

Claim/Objective	Investment in or contribution to the transition of undertakings/economic activities or other assets towards sustainability or contribution to such transition.
Minimum alignment	70% in investments to meet a clear and measurable transition objective related to sustainability factors, including environmental or social transition objectives. Investments in issuances by public sector bodies are excluded, except for use of proceeds instruments meeting specific criteria. Considered to be met in case of a minimum exposure of 15% to taxonomy-aligned economic activities.
Exclusions	companies involved in any activities related to controversial weapons; companies involved in the cultivation and production of tobacco; companies that benchmark administrators find in violation of the United Nations Global Compact (UNGC) principles or the Organisation for Economic Cooperation and Development (OECD) Guidelines for Multinational Enterprises; companies that derive 1 % or more of their revenues from exploration, mining, extraction, distribution or refining of hard coal and lignite; companies developing new projects for the exploration, extraction, distribution or refining of hard coal and lignite, oil fuels or gaseous fuels; and companies developing new projects for, or do not have a plan to phase-out from the exploration, mining, extraction, distribution, refining or exploitation of hard coal or lignite for power generation. Under certain conditions, these exclusions do not apply to investments in use of proceeds instruments (e.g. European Green Bonds).
PAIs	Identification and disclosure of PAIs of investments on sustainability factors, explanation of actions taken to address impacts.
Alternative	The minimum alignment, the exclusions and identification and disclosure of PAIs considered to be met when managed with reference to an EU climate-transition benchmark or an EU Paris-aligned benchmark.
Eligible assets	investments in portfolios replicating or managed in reference to an EU climate-transition benchmark or an EU Paris-aligned benchmark; taxonomy-aligned economic activities (including transitional activities and Taxonomy-eligible activities becoming Taxonomy-aligned); investments in undertakings of economic activities with a credible transition plan as regards at least one sustainability factor at the level of the undertaking of at activity level; investments in undertakings or economic activities with credible science-based targets; investments with a credible sustainability-related engagement strategy, targeting specific changes with defined milestones and integrating escalations actions; investments pursuant to Article 9(2) in combination with the foregoing investments; investments with a credible transition target at portfolio level, such as reduction of portfolio emissions; or other investments with proper justification.
Impact "label"	Available

Sustainable (Article 9)

Claim/Objective	Investment in sustainable undertakings, sustainable economic activities, or other sustainable assets, or contributing to sustainability.
Minimum alignment	70% in investments to meet a clear and measurable objective related to sustainability factors, including environmental and social objectives. Investments in issuances by public sector bodies are excluded, except for use of proceeds instruments meeting specific criteria. Considered to be met in case of a minimum exposure of 15% to taxonomy-aligned economic activities.
Exclusions	companies involved in any activities related to controversial weapons; companies involved in the cultivation and production of tobacco; companies that benchmark administrators find in violation of the United Nations Global Compact (UNGC) principles or the Organisation for Economic Cooperation and Development (OECD) Guidelines for Multinational Enterprises; companies that derive 1 % or more of their revenues from exploration, mining, extraction, distribution or refining of hard coal and lignite; companies that derive 10 % or more of their revenues from the exploration, extraction, distribution or refining of oil fuels; companies that derive 50 % or more of their revenues from the exploration, extraction, manufacturing or distribution of gaseous fuels; companies that derive 50 % or more of their revenues from electricity generation with a GHG intensity of more than 100 g CO2 e/kWh; companies developing new projects for the exploration, extraction, distribution or refining of hard coal and lignite, oil fuels or gaseous fuels; and companies developing new projects for, or do not have a plan to phase-out from the exploration, mining, extraction, distribution, refining or exploitation of hard coal or lignite for power generation. Under certain conditions, these exclusions do not apply to investments in use of proceeds instruments (e.g. European Green Bonds).
PAIs	Identification and disclosure of PAIs of investments on sustainability factors, explanation of actions taken to address impacts.
Alternative	The minimum alignment, the exclusions and identification and disclosure of PAIs considered to be met when managed with reference to an EU Paris-aligned benchmark.
Eligible assets	investments in portfolios replicating or managed in reference to an EU Paris-aligned benchmark; taxonomy-aligned economic activities; investments in European Green Bonds; investments (including co-investments) that finance undertakings, projects or portfolios benefiting from an EU budgetary guarantee or financial instruments under EU programs pursuing environmental or social objectives; investments in EuSEFs; or investments in comparable assets as the foregoing with a proper justification
Impact "label"	Available

V. Combination of categorised products and fund-of-funds

The proposal clarifies the treatment of products investing in categorised products (i.e. fund-of-funds).

Such products may themselves qualify for a category by meeting the 70% test via investments in other categorised products and complying with relevant exclusions. This means that, in effect, there is no need to "look-through" fund-of-funds products to the underlying investments.

Non-categorised products investing in categorised products must disclose the composition by category and provide information on the uncategorised portion (including such portion's objective, strategy and exclusions).

Products investing across different categories will either fall within the transition category (in case mixing sustainable or transition products) or within the ESG basics category (in case mixing products from any of the three categories). Such products must not use sustainability claims in their names, but may make claims in marketing communications if they are fair, clear, and consistent with disclosed composition.

VI. Non-categorised products

Non-categorised products may include sustainability-related information in their pre-contractual disclosures on a voluntary basis (other than the information reserved for a categorised product). However, such disclosures are restricted as such information:

must not be a central element of the pre-contractual disclosures (i.e., it must be secondary to the presentation of the product's characteristics and neutral as well as represent less than 10% of the presentation of the investment policy);
must not be included in the PRIIP KIDs;
must not constitute a claim in the meaning of Articles 7, 8 or 9; and
must not include sustainability-related claims in their names and marketing communications.

Further disclosures are required in the periodic reports.

VII. Naming and marketing communications

The proposal also includes a new article on marketing communications and naming rules.

Sustainability-related terms in product names and marketing communications are reserved to categorised products, presumably overruling the existing ESMA Guidelines on the use of sustainability-related terms in funds names.

Products using the term “impact” in their names must either be categorised as "sustainable" (Article 9) or "transition" (Article 7) with an impact objective, i.e., a pre-defined, positive and measurable social or environmental impact.

In respect of combining products as well as non-categorised products, please see sections V. and VI. above.

Where products disclose ESG ratings in their marketing communications, website disclosures must mirror the transparency obligations under the ESG Ratings Regulation.

VIII. Data

The proposal includes new rules as regards the documentation and disclosure (upon request) of the use of data sources and estimates.

IX. Closed-ended products

The proposal includes an exemption on a voluntary basis for closed-ended products created and distributed before the application date of SFDR II.
Importantly, the exemptions for alternative investment funds only marketed to professional investors provided for in the leaked draft version of the proposal has been deleted.

X. Delegated Acts

The European Commission is empowered to establish delegated acts concerning, in particular:

The conditions for investments to contribute to a transition-related objective;
The conditions for investments integrating sustainability factors;
The conditions for investments contributing to a sustainability-related objective; and
templates for pre-contractual disclosures (not more than two pages for and one page for impact-related disclosures) and periodic disclosures (not more than two pages).

XI. Implementation, timing, and supervision

The publication of the proposal on 20 November 2025 initiates the European legislative procedure, including negotiations between Parliament and Council. Once these negotiations are finalised, the new SFDR will become applicable 18 months after its entry into force (i.e. 18 months after twentieth day following its publication in the Official Journal).

Insurance- and pension-based products not covered by ESMA fund name guidelines receive a 12-month delayed application for categorisation and disclosures.

Importantly, Member States are precluded from gold-plating by imposing additional transparency requirements or categorisation criteria to prevent fragmentation.

The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to.
Readers should take legal advice before applying it to specific issues or transactions.