The European Union is preparing one of its most consequential updates to sustainable finance regulation since the introduction of the Sustainable Finance Disclosure Regulation. The proposed revision, which restructures fund classifications and changes how sustainability is defined, is expected to significantly shrink the universe of investment products allowed to market themselves as sustainable. Analysts at Morningstar Sustainalytics estimate that the majority of EU funds will now fall into the non-sustainability category, marking a sharp departure from the current landscape in which many products are labelled as environmental, social or governance focused. The overhaul is designed to combat greenwashing and provide clearer, more rigorous standards for investors seeking authenticity in sustainable investment.

A New Classification System That Redefines the Market Mix

Under the draft framework, the existing Article 8 and Article 9 categories will be replaced with three new labels. Transition funds, assigned under Article 7, will be designed for companies that are actively shifting their operations toward sustainability, although their asset footprint is expected to remain small due to strict exclusions on fossil fuel involvement and demanding engagement requirements. The sustainable fund category under Article 9 may see some growth, but projections indicate it will account for no more than seven percent of the total EU fund market. The largest structural change occurs in the space previously occupied by Article 8 funds. The new category, ESG basics, will cover a narrower range of products and may decline from its current majority status to somewhere between thirty two and forty one percent of assets under management. This decline is expected to push a large number of existing products back into the non-sustainability classification.

Non-Sustainability Funds Become the Dominant Category

The reorganisation reshapes the market in a way that places Article 6 funds, which have no sustainability designation, at the centre of the European fund universe. Morningstar estimates that between fifty two and seventy percent of products will fall into this category once the new rules take effect. The shift reflects the EU’s intention to create strict, sharply defined sustainability categories rather than broad labels that could cover a range of investment styles. The aim is to improve the ability of investors to distinguish between funds that integrate sustainability as a core investment strategy and those that simply consider ESG factors among many inputs. The new Article 7, Article 8 and Article 9 categories will represent smaller but more clearly delineated segments within this broader market structure.

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Strengthening Governance and Curbing Greenwashing Risk

One of the most significant aspects of the revision is the removal of the previous definition of sustainable investment. Instead, the new system will rely on category-based criteria that must be met uniformly across funds seeking to qualify. This change is intended to enhance comparability between products and reduce ambiguity that previously allowed managers to interpret sustainability thresholds with wide discretion. The updated framework brings tighter governance requirements, including additional scrutiny of engagement practices, enhanced reporting expectations and greater alignment with the broader goals of the EU Green Deal. Market experts believe the transition will require considerable adjustment from asset managers who have relied on the flexibility afforded by earlier rules.

Navigating the Transition to a More Regulated Sustainable Investment Landscape

The coming months will involve detailed discussions on technical elements such as thresholds for category qualification, treatment of Paris-aligned benchmarks and final naming conventions. These decisions will influence how investors navigate the market and how managers structure portfolios to meet the stricter expectations. The revision marks a decisive shift for European sustainable finance. A smaller share of products will be able to advertise sustainability credentials, but those that qualify will be subject to stronger oversight and clearer standards. Non-sustainability funds will dominate the market numerically, yet the credibility of the sustainable segment is expected to improve as the rules tighten.

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A More Focused but More Demanding Era for EU Sustainable Funds

In summary, the SFDR overhaul is set to redraw the boundaries of sustainable investment within the European Union. Transition funds, ESG basics and sustainable funds will form a more limited portion of total AUM, while non-sustainability funds become the default category for most investment products. The revisions aim to restore confidence in sustainability labels and give investors greater certainty about what qualifies as genuinely sustainable. For asset managers, the new framework marks the beginning of a more disciplined, more transparent era that will reshape how sustainability is integrated into European investment products.

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