SFDR 2.0: The overhaul takes shape

The Sustainable Finance Disclosure Regulation (SFDR) is undergoing a fundamental transformation. Almost a year after the European Commission published its long-awaited legislative proposal on November 20, 2025, the co-legislative process is now well advanced. The European Parliament (EP) and the Council of the EU have adopted their respective positions, and trilogue negotiations are expected to open on October 22, 2026 under the Irish Presidency, with both co-legislators aiming for a deal before the end of that Presidency, although the final agreement could slip into early 2027.

Application is not expected before January 1, 2029, as both co-legislators provide for application 24 months after entry into force.

This alert provides EEA and non-EEA asset managers with a clear-eyed assessment of where the discussions stand today and where the points of contention lie.

The direction of travel is unambiguous: SFDR 2.0 will replace what was originally a disclosure-only framework with a prescriptive product categorisation regime, backed by binding investment thresholds, mandatory exclusions, and strict naming and marketing rules. The strategic question for every asset manager is no longer whether to engage with the new framework, but how and when.

For A&O Shearman's initial analysis of the Commission proposal, see its eAlert: SFDR 2.0: overhaul impact of the new categories and disclosures on funds and asset managers.

Reminder of the SFDR 2.0 Commission’s proposal

From disclosure to categorisation

The Commission’s proposal marks a decisive pivot. Under the current SFDR, Articles 8 and 9 are designed as disclosure obligations, not product labels. In practice, however, the market treated them as quasi-labels, creating inconsistent market practices, supervisory friction, and greenwashing risk.

The Commission’s proposal replaces this ambiguity with three explicit, criteria-based product categories:

• Transition (Article 7): For products investing in, or contributing to, clear and measurable transition objectives relating to sustainability factors. This fills a longstanding policy gap by formally recognising transition finance strategies, including engagement-based approaches, provided they are combined with another credible transition route and credible decarbonisation plans.
• ESG Basics (Article 8): For products with credible ESG integration that goes beyond the mere consideration of sustainability risks. This is the broadest category, designed for a range of ESG approaches.
• Sustainable (Article 9): For products pursuing clear and measurable sustainability objectives, such as investments in companies or assets that already meet high sustainability standards.

Categorisation is mandatory for any product wishing to make sustainability-related claims in its name or marketing communications.

Alongside these three standalone categories, a new Article 9a addresses financial products that combine categorised products or otherwise mix investment approaches, such as funds-of-funds, multi-option products, and pension or insurance-based investment products offering a choice of underlying options.

This combined product category can be further sub-divided into:

• Categorised combined products that meet the 70% threshold of a single category (Article 9a (1)): for products that meet (i) the 70% threshold of a single category by combining investments in categorised products and/or eligible investments of the relevant category and (ii) the applicable exclusions. These products are treated as falling within that category.
• Non-categorised combined products that do not meet the 70% threshold of a single category (Article 9a (2)): for products investing in at least two categorised products but falling short of the threshold for a single category. They are treated as non-categorised products but may disclose the share of underlying categorised products and their composition through the pre-contractual disclosures of underlying categorised products. Direct holdings of eligible investments do not count towards the threshold.

Impact add-on for transition and sustainable categories

Impact investing is formally recognised and protected by an “impact add-on” available for Transition and Sustainable products that have the objective of generating pre-defined, positive and measurable social or environmental impact. Only products using the add-on may use “impact” in their names.

Common architecture to the three proposed categories

All three categories share a common structural framework:

• A binding 70% minimum investment threshold linked to the category’s stated objective, measured using credible sustainability indicators. A phase-in period is permitted, recognising that alternative and private asset strategies require time to deploy capital fully.
• Safe harbours for Transition and Sustainable categories: Portfolios tracking or managed by reference to an EU Climate Transition Benchmark (CTB) or Paris-Aligned Benchmark (PAB) are deemed to meet the criteria of the relevant category. A minimum 15% EU Taxonomy-aligned investments threshold also creates an EU Taxonomy safe harbour for the 70% criterion.
• Eligible investment types: a non-exhaustive list accommodating diverse approaches, including best-in-class (against a benchmark or proven track record), transition strategies with transition plan or science-based targets, and investments in EU Green Bonds or EuSEFs. Engagement strategies are not a standalone-eligible ESG strategy and must be combined with another transition route.
• Minimum exclusions: the applicable exclusions become progressively stricter across the categories.

Minimum exclusions per category (Art. 7 Transition / Art. 8 ESG Basics / Art. 9 Sustainable):

• CTB exclusions (controversial weapons, tobacco, UNGC principles and OECD Guidelines for Multinational Enterprises (OECD Guidelines)): Art. 7 yes / Art. 8 yes / Art. 9 yes
• PAB exclusions, companies deriving:
  • ≥ 1% revenue from hard coal and lignite: Art. 7 yes / Art. 8 yes / Art. 9 yes
  • ≥10% revenue from oil fuels: Art. 7 no / Art. 8 no / Art. 9 yes
  • ≥50% revenue from gaseous fuels: Art. 7 no / Art. 8 no / Art. 9 yes
  • ≥50% revenue from electricity generation with high GHG intensity (>100g CO2e/kWh): Art. 7 no / Art. 8 no / Art. 9 yes
• New fossil fuel exclusions:
  • New fossil fuel production projects (exploration, extraction, distribution, or refining of hard coal, lignite, oil, or gas (together Fossil Fuels)): Art. 7 yes / Art. 8 no / Art. 9 yes
  • Coal/lignite power generation without phase-out plan: Art. 7 yes / Art. 8 no / Art. 9 yes

Transition and Sustainable categories benefit from exceptions from the prohibited investments above.

Exceptions to excluded investments (Art. 7 / Art. 8):

• Use of proceeds of:
  • EU Green Bonds: Art. 7 yes / Art. 8 yes
  • not financing controversial weapons, tobacco, hard coal/lignite: Art. 7 yes / Art. 8 yes
  • not financing oil revenue ≥10%, gas revenue ≥50% or high GHG intensity electricity revenue ≥50%: Art. 7 no / Art. 8 yes
• Provided that the issuer:
  • complies with UNGC principles and OECD Guidelines: Art. 7 yes / Art. 8 yes
  • does not develop new Fossil Fuels production projects or coal/lignite power-generation projects without phase-out plan: Art. 7 no / Art. 8 yes
• Principal Adverse Impacts (PAIs) disclosures for Transition and Sustainable categories: Transition and Sustainable products must identify and disclose principal adverse impacts and actions taken to address PAIs.

Non-categorised products (Article 6A)

Products that do not meet the criteria for any category face tight restrictions. Under a new Article 6a, non-categorised products may include limited, neutral information on sustainability factors in pre-contractual disclosures, but this information must not be a “central element” (i.e., occupy less than 10% of the investment strategy section in volume) and must not constitute a sustainability-related claim. Non-categorised products cannot use ESG-related terms in their names or sustainability-related claims in marketing communications.

Key simplifications and reduced scope

The proposed revised framework eliminates several burdensome features of the current regime:

• Financial advisers and credit institutions or investment firms providing portfolio management are carved out from SFDR scope.
• Entity-level PAI statements and remuneration policy disclosures are deleted.
• EU Taxonomy disclaimer is removed.
• Article 10 product website disclosures are no longer required as a standalone document. Pre-contractual and periodic disclosures must still be made available on the FMP’s website, although hyperlinks will suffice.
• Pre-contractual disclosure templates are capped at two pages (three pages for impact products).
• The definition of “sustainable investment” (including the Do-No-Significant-Harm test) is removed, with the underlying concepts embedded within the product categories and operationalised through minimum exclusions.
• While an earlier draft permitted an opt-out for AIFs marketed exclusively to professional investors, this was removed from the final Commission text.

That proposal is not the final law: it is the starting point for negotiations between the Council of the EU, representing the Member States’ governments and the EP, representing EU citizens, and its content may still change significantly. The two co-legislators, the EP and the Council, each examine the Commission’s proposal separately and adopt their own position, often amending the Commission’s text. Both co-legislators have now settled their positions, so the three institutions can meet in informal negotiations known as “trilogues”, with the Commission acting as a facilitator, to agree a single compromise text. The following section describes where each legislator stands before the trilogues start.

State of the co-legislative process

Where things stand

The period since November 2025 has been marked by intensive institutional activity. The ordinary legislative procedure is now actively progressing along two parallel institutional tracks:

• Council of the EU: On June 24, 2026, the Council agreed its negotiating mandate on SFDR 2.0. The category names remain provisional. The Council text is, broadly, more industry-friendly than the EP position on the issues of greatest operational significance.
• EP: The ECON Committee adopted its negotiating position on September 10, 2026, which was officially endorsed by the EP on October 7, 2026.
• Trilogue: Interinstitutional negotiations are expected to commence in October 2026. A political agreement on the Level 1 text could be reached by the end of 2026 or in early 2027.

The three institutions agree on the fundamental architecture:

• three product categories
• the 70% investment threshold concept
• the disclosure of PAIs
• the concept of an EU Taxonomy safe harbour (but with diverging thresholds)
• the CTB/PAB safe harbour for Transition and Sustainable products (although the EP has considered its deletion)
• the removal of financial advisers and portfolio management from scope
• simplification of entity-level disclosures (limited to disclosure of the integration of sustainability risks), although the EP introduces new annual disclosures of (i) the proportion of assets under management invested in each category, (ii) the proportion of number of products invested in each category and (iii) the total number of products in each category
• simplified disclosure templates, with a concise, two-page Level 2 approach
• at product level, financial market participants (FMPs) only need to publish pre-contractual and periodic disclosures on their website
• limitation of sustainability-related information for non-categorised products to 10% of the investment strategy’s content and to incidental presentation
• strict naming and marketing rules for categorised products
• and use of data and estimates.

Despite differing ambition levels, the Council and EP are aligned on several foundational elements, which differ from the Commission’s proposal:

• due diligence and monitoring obligations for transition approaches (documented due diligence, monitoring of underperformance, and annual review)
• a disclaimer for non-categorised products, although the wording differs (see below)
• extension of the Commission’s application period from 18 to 24 months after entry into force allowing more time for FMPs to adapt
• sovereign debt: use of proceeds only for Sustainable, but a diverging approach on ESG Basics and Transition (see below)
• and reintroduction of the professional investors opt-out for AIFs exclusively made available to professional investors (covering Arts 6a, 7, 8 and 9 in Council and EP as well as Art 13(3) for Council). Article 13(3) prohibits sustainability-related claims in non-categorised products’ names and marketing, as well as communications.

Notwithstanding these convergences, the EP and Council positions diverge materially on several consequential points, with the EP position broadly more stringent than that of the Council. The following summarises the most important areas of disagreement:

Criteria applicable to the categories

• EU Taxonomy safe harbour (Transition/Sustainable): While the Council agrees with the Commission’s proposal for a 15% EU Taxonomy-aligned investment safe harbour, the EP increases the threshold to 20% for the Sustainable category (15% maintained for Transition) and requires disclosure of the proportion of EU Taxonomy-aligned investments for ESG Basics (a softer requirement than the safe harbour introduced in previous EP intermediary texts).
• Exclusions and exceptions to prohibited investments:
  • Violation of UNGC principles or OECD Guidelines: While the Council agrees with the Commission’s exclusion across all categories with respect to violations of UNGC principles/OECD Guidelines, EP relaxed the scope by only covering those violations that are not effectively addressed and, where appropriate, remediated.
  • Fossil fuel exclusion (Transition): The Commission’s new fossil fuel exclusion is based on activity. It excludes companies that develop new fossil fuel projects, or that develop new hard coal or lignite power generation projects or have no plan to phase out of it. The Council and the EP both replace this with a revenue-based exclusion. It covers any company that derives revenues from the exploration, extraction, mining or refining of hard coal and lignite, oil fuels or gaseous fuels. Such a company can still be held if it allocates at least 20% of CapEx to EU Taxonomy-aligned investments and has a time-bound and measurable strategy to reduce GHG emissions (Scopes 1 and 2) in line with the Paris Agreement. The EP adds two further requirements: (i) a phase out plan where hard coal/lignite is used for power generation, carried over from the Commission’s approach; and (ii) over a rolling three-year period, a higher average proportion of CapEx allocated to EU Taxonomy-aligned activities than to new fossil fuel development projects. The Council deletes the cross-reference to the PAB hard coal/lignite exclusion so hard coal/lignite companies meeting the conditions can be eligible, while the EP retains it. Under the EP text, any company with 1% or more of its revenues from hard coal/lignite stays excluded, so the derogation in practice only helps companies below that 1% threshold. Both legislators also take “distribution” out of the list of covered activities. However, companies with 1% or more of their revenues from hard coal/lignite distribution would still be excluded under the EP text through the PAB hard coal/lignite exclusion.
  • General-purpose public sector issuers (Sovereign Debt): Both the EP and Council permit investments in general-purpose EU public sector issuers if aligned with the transition objective based on methodologies and if they account for less than 15% of the 70% threshold for Transition or based on appropriate methodologies for ESG Basics. The EP additionally extends the use-of-proceeds exception to cover loan facilities alongside EU Green Bonds and instruments whose proceeds do not fund CTB-excluded activities or hard coal/lignite. Both the EP and Council agree that general-purpose EU public sector debt should count towards the 70% threshold in the Transition and ESG Basics categories when assessed through appropriate methodologies. However, the EP requires that, across all three categories, general-purpose public sector investments falling within the freely allocatable 30% of investments must be “consistent with the stated sustainability-related objective or strategy of the financial product”. The Council only requires alignment with the product’s stated objective when the investment is accounted in the 70% threshold (Transition and ESG Basics).
  • Eligible investments: The Council specifically addresses investments in private and real assets (defined by cross-reference to ELTIF Regulation), which may be eligible for Transition if they satisfy the “credible contribution to the transition” test through documented evidence/methodology, rather than needing to meet one of the standard transition pathways, for ESG Basics if integration of sustainability factors can be demonstrated through asset-class appropriate evidence and for Sustainable if contribution to the environmental or social objective can be evidenced by a proven positive track record. The EP does not include a carve-out for private and real assets in any category.
• PAI disclosures: The Commission lets FMPs choose and identify the relevant PAI indicators for measuring compliance and progress towards the stated objective. Both the Council and EP are more prescriptive.
  • At Council level, at least three mandatory indicators must be chosen from a delegated-act list for Transition and Sustainable, plus an additional fourth mandatory fossil-exposure indicator must be disclosed for investments in fossil fuel transitioning companies (Transition), with an alternative possible if none is relevant. Freely chosen indicators apply for ESG Basics.
  • At EP level, a three-tier mandatory PAI regime across all three categories (mandatory list indicators, material indicators, and voluntary additions), including for ESG Basics, which the Commission and Council exempt. If mandatory PAIs are irrelevant, an alternative methodology may be used for Transition.

PAIs regime (EP) (Art. 7 / Art. 8 / Art. 9):

• Mandatory PAIs:
  • Fossil fuel: Art. 7 yes / Art. 8 yes / Art. 9 yes
  • GHG: Art. 7 yes / Art. 8 no / Art. 9 yes
• Mandatory material indicators:
  • Freely chosen from the delegated act list: Art. 7 yes / Art. 8 no / Art. 9 no
  • Activities negatively affecting biodiversity-sensitive areas: Art. 7 no / Art. 8 no / Art. 9 yes
  • Companies without UNGC and OECD guidelines compliance monitoring: Art. 7 no / Art. 8 no / Art. 9 yes
• Voluntary PAIs: Art. 7 no¹ / Art. 8 yes / Art. 9 yes
• Engagement strategy disclosure: The EP introduces a mandatory comply-or-explain engagement disclosure across all categories, including the proportion of the portfolio covered by these activities; the Council does not impose this.

Non-categorised products (Article 6a)

• Permitted disclosures: Both the Council and EP retain the Commission’s proposal to limit information on the consideration of sustainability factors to 10% of the investment strategy’s presentation, but the Council softened the wording by removing “less than” and specifying that it is not a hard cap.
• Disclaimer: Both the Council and EP introduce a prominent mandatory disclaimer. The Council disclaimer states that the product does not meet the criteria of the categorised products. The language softened is by EP: the product is non-categorised and there is no requirement to disclose its negative environmental impact.
• Use of labels: While both the Council and EP retain the Commission’s proposal to clarify that the Regulation is “without prejudice” to voluntary sustainability-related labelling schemes exceeding the requirements of the categories, the EP now explicitly prohibits any reference by a non-categorised product to such a label that does not exceed the requirements of the categories.

Review scope

• PRIIPs and structured products: The EP compromise leaves PRIIPs out of SFDR 2.0 for now but requires the next SFDR review to assess whether PRIIPs should be brought within scope. The Council in turn wishes to consider structured products in scope of SFDR at the next review.

Data and estimates

• Disclosure: The Commission proposes that information be disclosed on investor request, an approach retained by the EP. The Council instead includes systematic disclosure of their use, source, data providers and methodology used. The EP compromise also provides that the Commission, in consultation with the ESAs and competent authorities, may issue recommendations to improve the transparency, reliability and comparability of non-confidential or non-proprietary data and estimate methodologies used for SFDR purposes.

Timing

• Immediate burden relief: The Commission and Council do not provide immediate relief for removed disclosures which would take effect on application date. The EP proposes that certain burden-reduction provisions (entity-level PAI/remuneration disclosures) apply from the entry into force of SFDR 2.0.
• SFDR review: The EP is aligned with the Commission to review SFDR application within 36 months while the Council extends that period to 60 months. Both the Council and EP propose to review the appropriateness of the EU Taxonomy safe harbour threshold.

What to watch

The most contentious topics in the trilogues are likely to be the fossil fuel exclusions for the Transition category, the deviations from the mandatory investment exclusions and the PAI indicators (including for ESG Basics). Other topics on which the EP and Council positions are closer or more technical in nature, such as the treatment of sovereign debt, the professional investors opt-out, the human rights exclusion, the 24-month application period, engagement disclosures and the rules for non-categorised products, may be easier to resolve, although they may still prove sensitive.

Industry Impact

• Product mapping: Every fund currently disclosing under Article 8 or Article 9 will need to be mapped against the new category criteria, including the 70% threshold minimum exclusions and eligible investment requirements. The direction is clear but detailed Level 2 measures will determine the operability. The Council’s compromise text provides welcome flexibility for these structures, including accommodation for multi-option products and funds-of-funds and documented asset-class-appropriate evidence. Many Article 8 funds, particularly those with limited binding commitments and those relying on exclusion strategies only, may not qualify for any category. Asset managers will have to decide whether to enhance strategies to meet ESG Basics criteria or accept the consequences of non-categorisation (loss of ESG naming rights and marketing flexibility).
• Closed-ended funds opt-out: Closed-ended funds created before and no longer distributed after the SFDR 2.0 application date may opt out entirely. However, the EP proposes that they continue reporting under SFDR 1.0 pursuant to existing contractual commitments. Existing side letters may need to be reopened on a case-by-case basis.
• Professional investors opt-out: If finalised, the opt-out will be significant for asset managers managing professional-only AIFs, including those managed by non-EEA managers and distributed in the EEA under national private placement regimes.
• Non-EEA asset managers distributing into the EEA: SFDR 2.0 maintains extraterritorial application to non-EEA funds marketed into the EEA. Non-EEA funds will be subject to the same categorisation, disclosure, naming, and marketing rules as their EEA counterparts. The naming rules under Article 13 expressly apply to non-EEA products marketed to EEA investors (and may replace the ESMA Guidelines on fund names for all in-scope products).
• The mandatory exclusion lists (including restrictions on fossil fuel investments) may create tension with certain U.S. state-level anti-boycott or anti-ESG legislation, particularly for funds with significant U.S. investor bases. Asset managers operating across both regimes will need to consider whether dual-strategy or ring-fenced structures are required.
• Sustainability-related communications: Non-categorised funds will face severe restrictions on what they can communicate about their sustainability approach in marketing materials directed at EEA investors. This poses a practical challenge for non-EEA asset managers with global strategies that integrate ESG considerations but may not meet the specific criteria of SFDR 2.0’s categories. In addition, it remains to be seen in the final text whether funds that chose to be non-categorised may continue to reference voluntary labels.

Compliance timelines

Based on the current trajectory, the earliest possible application date is January 1, 2029 (assuming Level 1 adoption by the end of 2026 or early 2027, followed by a two-year transitional period). However, several important sequencing points remain unresolved:

• Level 2 delegated acts (specifying disclosure templates, eligible investment conditions, and PAI indicators) will be developed by the Commission following Level 1 adoption. There is currently no statutory mechanism guaranteeing that Level 2 measures will be in force by the time the Regulation applies.
• The existing SFDR Delegated Regulation will be repealed from the SFDR 2.0 application date.
• The ESMA guidelines on funds names will need to be formally superseded but none of the institutional texts currently address how this transition will operate.

Prepare for the transition, not the transition period

Although the final text will not emerge until trilogues conclude, the structural features of SFDR 2.0 are clear enough to begin planning:

• Map existing products: Assess current products against the three new categories. Identify which existing Article 8 and 9 products are likely to qualify under the new framework, which will require strategy enhancements, and which may fall outside the regime entirely (existing side letter arrangements may need to be considered).
• Assess exclusion exposure: Apply the proposed exclusion lists to current portfolios. The fossil fuel exclusions, particularly for the Transition and Sustainable categories, are more restrictive than those under the ESMA guidelines on fund names and will require careful portfolio screening.
• Evaluate data infrastructure: The requirement for formalised and documented arrangements with external data providers, together with documented methodologies for own estimates, will require operational upgrades. FMPs should now inventory their data sources and identify gaps.
• Audit naming and marketing materials: The naming and marketing restrictions will be among the most immediately consequential elements for product distribution. Any fund using ESG or sustainability-related language in its name or marketing materials that does not meet category criteria will need to rebrand.

The compliance horizon may seem distant, but the restructuring required—reclassifying products, redesigning disclosures, reassessing side letter arrangements, rewriting marketing materials, training compliance, legal and risk alongside distribution teams, and rebuilding data governance—is substantial. Asset managers who wait for the final text will face a compressed implementation window. Those who start now will have a strategic advantage.

Footnotes

¹ For Transition, FMPs may use another transparent methodology appropriate to the investment strategy when none of the listed PAIs are relevant.

Authors:

• Kristof Meynaerts, Partner at A&O Shearman
• Miao Wang, Partner at A&O Shearman
• Vittoria Faraone, Partner at A&O Shearman
• Severina Käppeli, Partner at A&O Shearman
• Antoine Sarailler, Partner at A&O Shearman
• Benjamin Lacourt, Partner at A&O Shearman
• Matthew Townsend, Partner at A&O Shearman
• Dara Ingallo, Senior Knowledge Lawyer at A&O Shearman
• Cédric Danois, Senior Associate at A&O Shearman
• Romane Chéry, Senior Associate at A&O Shearman
• Danae Wheeler, Senior Associate at A&O Shearman