Ahead of the introduction of a EU-wide transition fund category via SFDR 2.0, Sustainable Investor asked experts how it could support net zero investment strategies.
The European Commission’s review of its Sustainable Finance Disclosure Regulation (SFDR) – the key legislative framework for ‘green’ investment vehicles – is imminent. The commission is widely expected to unveil proposals in November to replace Article 6, 8, and 9 funds with three new product categories, in line with the recommendations of the Platform on Sustainable Finance (PSF), released in December last year.
Asset owners, fund managers, and retail investors have long struggled with the complexities of SFDR – originally devised to govern disclosures by funds with different sustainability objectives and characteristics, but used in practice to as fund labels. A key problem was the lack of clear definitions that could reliably distinguish between ‘light green’ Article 8 and ‘dark green’ 9 funds, with the blurred boundaries leading first to self-labelling and then accusations of greenwashing.
Despite the difficulties, responses to a commission consultation released in May 2024 revealed a lack of consensus on proposals to reform or replace SFDR. Guidelines introduced by the European Securities and Markets Authority (ESMA) in November provided greater certainty, by requiring funds invest at least 80% of their assets in line with sustainability-related terms in their name.
The PSF then pointed the way forward, calling for a proposed scheme which would include three product categories: sustainable; transition; and ESG collection, with the latter including all green funds that do not meet the criteria set for the first two. While the direction of travel has been known for almost a year, much is to be decided, especially for the critical ‘transition’ category, given the urgent need to transition business models across the most carbon-intensive and hard-to-abate sectors.
Ahead of the release of the SFDR review – and its inevitable consultation – Sustainable Investor asked leading sustainable investment experts to identify the challenges ahead and the key considerations for asset owners when assessing the role of transition funds in their net zero investment strategies.
Q1: What are the main challenges for regulators and managers in defining and designing transition funds?
Leo Donnachie, Senior Policy Manager – Sustainable Finance, Institutional Investors Group on Climate Change (IIGCC):
“A key challenge for both regulators and fund managers is the ongoing uncertainty around what qualifies as a ‘sustainable investment’ under current regulations. This lack of clarity makes it difficult to determine whether stricter definitions will allow appropriate investment in high-emitting or hard-to-abate sectors, which are essential to decarbonising the real economy. Investors need to be able to channel capital towards these sectors to deliver genuine emissions reductions. The ambiguity within the SFDR framework on this point has been a major obstacle in the EU. By contrast, the UK has largely avoided this problem by introducing clearer product labels, including a dedicated transition category, which from the outset recognises the importance and credibility of these strategies.
“Another challenge is the absence of a shared view on how to assess the credibility of transition efforts within portfolio companies. Regulators need to strike a balance between setting standards that promote consistency and comparability, while still allowing flexibility for different investment approaches. At a minimum, transition-focused funds should prioritise investments that demonstrate credible transition plans and targets aligned with recognised frameworks such as the EU Taxonomy or the IIGCC’s Net Zero Investment Framework, ultimately supporting real-economy decarbonisation.”
Pierre Garrault, Senior Policy Adviser, Eurosif:
“Transition funds should contribute to the transition towards sustainability. A key distinction to prevent greenwashing is that investors should clearly demonstrate that these funds are in line with a credible transition strategy, at either portfolio or asset level, based on acknowledged and science-based criteria and KPIs. As part of the SFDR review, we support establishing a dedicated category for ‘transition’ funds with specific criteria to ensure this.”
Tom Willman, Regulatory Lead, Clarity AI:
“One of the main challenges is ensuring access to reliable, comparable, and decision-useful information to determine whether companies are genuinely on a credible transition path. Assessing this requires a detailed view across several data dimensions, including (but not limited to) emissions performance and targets, decarbonisation strategies, capital allocation to transition activities, and governance structures supporting delivery.
“Investors want to know: Are the targets ambitious and science-based? Is the company on track? Are the right incentives and oversight mechanisms in place to ensure delivery? Clear, verifiable data and consistent standards are essential to reduce greenwashing risk and build confidence.”
Eleanor Fraser-Smith, Head of Sustainability, Victory Hill Capital Partners:
“A clear transition category should sit on equal footing with sustainable funds. We need the whole economy to transition not just focus on already green assets. This could help capital to flow to hard-to-abate sectors, enabling infrastructure that are struggling to fund decarbonisation. The challenges in defining the funds and creating minimum standards and metrics demand pragmatism and flexibility.
“The first challenge is that this is a whole-economy transition, which adds complexity to any regulation because it is not sector specific and will look different across industries and locations. It requires every company to embed transition into its business model, strategy, finance, operations, risk, HR, engineering etc.
“The second challenge is the market and technology gap. In many high-emitting sectors the necessary technologies are early or not yet available at scale. Investment cycles are long meaning lock-in risk is real, and many solutions require significant capex and still carry a ‘green’ premium. Enabling infrastructure is also needed, from storage for captured carbon to new fuel transport and storage networks. These are very different types of transition investment.
“The third challenge is that corporate reporting frameworks are still bedding in. The Corporate Sustainability Reporting Directive (CSRD) and the Corporate Sustainability Due Diligence Directive (CSDDD) and related requirements are new and unevenly understood, so there will be a lag before managers have consistent data to understand roadmaps, design products and inform investors, particularly for smaller companies which is important considering much of the transition is mid-market led.
“The fourth challenge is the value chain. Many plans have limited Scope 3 coverage, lack capex detail and credible timelines, and struggle with boundaries across complex supply chains. We must assess the quality and feasibility of transition plans amid imperfect data and necessary assumptions. Thematic portfolios can hold very different assets across geographies with different priorities, which makes like-for-like portfolio reporting difficult. Uncertainty has to be acknowledged and managed.”
Q2: What metrics can and are being used to measure the outcomes of transition funds?
Jordan Griffiths, Senior Sustainable Investment Consultant, Barnett Waddingham:
“Whilst we’ve seen significant improvements in recent years, substantial data gaps and reliability issues remain, particularly around Scope 3 emissions and forward-looking metrics. Investors should exercise caution and avoid over-reliance on quantitative data alone when formulating strategies.
“The most robust approach combines qualitative and quantitative analysis with a focus on long-term direction of travel. We encourage investors to engage in discussions with their investment managers to understand their approach to data quality and the steps being taken to improve the reliability of transition plans.”
Pierre Garrault, Eurosif:
“Transition approaches are varied. The commission already highlighted some good examples of approaches that could be considered transition investments, based on standards and tools such as CSRD-aligned transition plans or the Taxonomy. These could be among the approaches included in a ‘transition’ category under SFDR.”
Hortense, Bioy, Head of Sustainable Investing Research, Morningstar Sustainalytics:
“What we will need to know now is to define whether criteria will be set at the asset level, as the Financial Conduct Authority (FCA) has done in the UK with the Sustainability Improvers label. The FCA has been very clear on this point, meaning it’s not enough to have a decarbonisation target at the portfolio level; every asset needs to be monitored. But in Europe, because you already have funds based on the Paris-aligned Benchmarks (PABs) and Climate Transition Benchmarks (CTBs) for which transition is tracked at the portfolio not the asset level.
“So the commission needs to decide whether they want to review the EU Benchmarks Regulation. Do they want to review the criteria and say it’s now not enough to have just a decarbonisation strategy at the portfolio level. And if they set criteria at the asset level, do companies need to have transition plans? If not, they would effectively be saying that funds that have either an emission reduction objective at the asset or portfolio level will qualify.”
Eleanor Fraser-Smith, Victory Hill Capital Partners:
“Minimum standards at portfolio level are blunt and don’t allow for nuance. The data and action plans sit at company or asset level, so managers need to exert influence on decision-making and secure regular reporting as well as require credible, time-bound plans that are transparent about constraints and allow milestones to adjust as technology, policy and supply chains evolve. Escalation plans also need to be flexible accounting against what is feasible in the sector and location.”
Q3: What are the most notable current shortcomings regarding inputs to investors about company transitions?
Leo Donnachie, IIGCC:
“A major ongoing challenge is the limited availability of high-quality, comparable and widely accessible data on company transition plans. This gap persists despite growing regulatory and voluntary disclosure efforts worldwide, and has been compounded by recent moves in some markets to scale back corporate reporting requirements.
“If investors could access consistent, reliable transition plan data based on credible, widely recognised frameworks, they would be better equipped to make informed investment decisions and engage constructively with companies. Instead, they face a patchwork of inconsistent or incomplete disclosure rules, forcing greater reliance on external data providers, estimates, and direct company engagement to fill information gaps.”
Silvia Merla, Head of Economic Policy Research, Algebris Investments:
“For transition investment strategies to be credible it is essential for investors to be able to access comprehensive and comparable data on corporate sustainability, and ideally for corporate transition targets to be science based and validated by independent third-party assessors. The recent Sustainability Omnibus initiative will reduce the breadth and depth of data on corporate sustainability available to investors and this make it more difficult for investors to evaluate the credibility of companies’ transition paths.”
Jordan Griffiths, Barnett Waddingham:
“The absence of a standard template for transition plans and associated metrics increases the need for significantly greater due diligence. Each company’s plan must reflect its specific characteristics, which makes comparison challenging.
“Critically, the mere existence of a transition plan is insufficient. Investors must determine whether a company’s transition plan is credible, but this assessment is difficult and requires judgement about the likelihood of successful implementation, even when a plan meets minimum criteria.”
Q4: What roles can transition guidance frameworks play in defining transition funds?
Leo Donnachie, IIGCC:
“Transition guidance frameworks are valuable tools for shaping and defining transition funds, as they help set clear standards and expectations for what credible climate action looks like. However, there is a real risk of repeating past mistakes by imposing rules on asset owners and managers before equivalent requirements exist for corporates.
“Investors depend on data from companies they invest in to manage climate risks and opportunities, and to align their portfolios with net zero goals. When regulators require investors to disclose information before corporates are required to report it, it disrupts the information flow across the investment chain and undermines effective climate action. For the system to work, corporates must report first so investors have the necessary data. The uncertainty over future CSRD disclosure requirements adds to this challenge and remains a significant concern.”
Jordan Griffiths, Barnett Waddingham:
“Transition guidance can set standards for the economy, enabling greater access to data, transparency, and accountability, which should allow capital to flow more efficiently to transition assets. However, it must also allow for flexibility and nuance across regions, sectors, market participants, and specific factors.
“We expect past issues associated with CSRD to be less prominent with transition planning, given the lower reliance on purely quantitative data. However, without a logical sequence, corporates first, then managers, then owners, later disclosures may lack reliable information.
“Crucially, any guidance framework must recognise that transition is not simply an emissions accounting exercise, but about supporting companies and their investments through their transition to a low-carbon economy.”
Tom Willman, Clarity AI:
“Many investee companies still don’t disclose the information needed to assess their transition progress. The Sustainability Omnibus adds further uncertainty about which companies will be required to report, and on which data points.
“We strongly support establishing a clear and robust definition of ‘transition’ within SFDR, but there’s a risk that the cart will once again be put before the horse, with investors required to report on information that companies have not disclosed under any regulatory requirement. In practice, this could lead investors to rely on voluntary disclosures, bilateral information requests, or third-party data providers.”
Q5: What role should stewardship play in the value proposition of transition funds?
Elise Attal, Head of European Policy, UN Principles for Responsible Investment:
“Transition funds should reward investments that demonstrate credible progress toward improved sustainability, but there is currently very little high-quality, forward-looking data that investors can use to assess companies’ progress in their portfolios and ensure their transition objectives are credible.
“In the absence of comparable and verifiable data, stewardship and engagement is critical for ensuring investee companies are committed to and proactive in their progress. Institutional investors should expect a fund’s stewardship standards to actively support its sustainability goals, through clear engagement plans, adequate resources, and a focus on driving measurable outcomes.”
Silvia Merla, Algebris Investments:
“The ability to demonstrate progress towards targets is going to be central to the credibility of transition funds strategies, so engagement will most likely take on an even more important role for these funds compared to e.g. sustainable investment funds. I believe one theme that will be key to engagement in this context will be around investee companies’ willingness to set science-based targets and report (voluntarily, if they no longer fall in the scope of CSRD) progress against those targets.”
Eleanor Fraser-Smith, Victory Hill Capital Partners:
“One way in which regulators could improve accountability and investor decision-making is by requiring transition-labelled products to publish their engagement plans and the asset-level transition plans. Managers would then need to be transparent about the KPIs used to judge progress, and how committed capex maps to specific transition levers at the asset. Periodic reporting would address any changes to the plans and any escalation steps if milestones were missed.”
Q6: How should SFDR transition funds evolve beyond ESMA’s minimum guidelines. How should SFDR 2.0 interoperate with UK fund labelling rules under the Sustainable Disclosure Regime (SDR)?
Pierre Garrault, Eurosif:
“The ESMA guidelines were a positive first step, by establishing basic expectations for funds using transition-related terms. However, we support complementing these with dedicated criteria, e.g. on engagement as part of the SFDR Review. We also support complementing the minimum exclusions for these funds, by extending them to activities linked to the first-time production, expansion or exploration of fossil fuels when companies have no credible commitments to phase out such activities. This would incentivise the transition of investee companies and support investors in justifying the credible transition strategy at portfolio / asset level for such funds.”
Tom Willman, Clarity AI:
“Building on the UK experience can help address some of its perceived weaknesses while also improving interoperability between the two frameworks. To give one example, a challenge in the UK has been defining what happens to assets that ‘improve’ sufficiently. In other words, when holdings achieve the sustainability standards set by the fund, should they then be removed? Clarifying these kinds of practical questions will be essential to ensure consistency and credibility across jurisdictions.”
Silvia Merla, Algebris Investments:
“In 2024, the European Supervisory Authorities seemed to suggest the sustainable and transition funds categories should be mutually exclusive, but this may not need to be the case. As the whole economy transitions, and if transition funds are effective, the companies in the portfolios of transition investment products should become progressively more sustainable over time. In that case, the portion of the portfolio that clears the sustainability threshold would progressively increase. There would seem to be no obvious reason to ‘force’ transition products to divest from companies that have switched to being sustainable. So there may be a rationale for allowing sustainable and transition investments to coexist within the portfolios of transition products, provided transparent disclosure rules are set.”
Hortense Bioy, Morningstar Sustainalytics:
“I’m not in favour of the creation of product categories in Europe. Instead, we should keep the existing SFDR disclosure regime, but simplify the disclosures, simplify MiFID II and simplify the conversation with clients. Product categories are nice in theory but in the UK the SDR labeling regime has created a niche market where you only have around 140 labelled funds, and only 14 with the improvers label. In the UK, some managers didn’t want to apply for a label because of the effort, time and lack of clarity. There’s likely to be consultation on the commission’s proposals, but we don’t want a situation again where regulators are going to have to clarify and add further complexity. There’s no appetite for more regulation.”
Q7: What balance should transition funds strike between decarbonising business models vs investment in climate solutions?
Jordan Griffiths, Barnett Waddingham:
“No two funds are created equal. We expect funds to sit across the entire spectrum, from those focused on decarbonising operations and business models, to those investing in solutions, with many taking a blended approach.
“Given that each transition plan depends on the specific aims, beliefs, and constraints of the investor, we believe all types of transition funds may have a place in an investor’s portfolio. An investor looking to reduce risk might favour decarbonisation of existing operations, whilst an investor aiming to contribute to real-world change might favour investment in solutions. In reality, we expect most investors – and therefore most funds – to take a blended approach that reflects their particular circumstances and objectives.”
Hortense, Bioy, Morningstar Sustainalytics:
“We’re at a very early stage. As well as targeting decarbonisation at the portfolio or asset level, funds could be investing in transition enablers, companies that focus on climate solutions or technologies. Equally, some investors might focus purely on the energy transition, investing in clean tech, while others might target transition bonds. So is it really possible to have a transition category, when today it means different things to different people? If you’re not strict enough with your criteria, could it lead to transition washing? Personally, I don’t think it should be the concern today. I think we should be full speed on transition and let the market innovate.”
Leo Donnachie, IIGCC:
“Transition funds should adopt a balanced approach, combining investments across a range of assets. This includes climate solutions and assets that are already sustainable, alongside those with the potential to improve their sustainability over time.
“This approach supports the FCA’s ‘mixed goals’ label, which recognises the value of diverse investment strategies within transition funds. At the same time, it is important that product categories remain mutually exclusive, with each having clearly defined and distinct outcomes to maintain clarity and credibility.”
