Our response to the European SFDR consultation

In September 2023, the European Commission opened a consultation to evaluate the success of the Sustainable Finance Disclosures Regulation (SFDR), the main instrument for market participants to disclose sustainability information to investors.

As a representative of Venture Capital funds and startups, at France Digitale we are convinced that the ongoing revamping of the SFDR scheme must take into account the specificities of this young market, as shown in our response to the European Commission’s consultation. VCs invest in startups and innovation. Yet, innovation inherently carries a risk and startups are unique companies that only achieve profitability after a significant period of time. There are two consequences of the above:

1- For startups that are part of VCs’ portfolios: the more early-stage or the more innovative a startup is, the more risk it takes to create a product or a service, and the more complicated it is to dedicate financial resources to robust extra financial reporting. Investments done in their positive transformation is therefore done at the expense of other expenditures, notably the innovative purpose of the company. 

2- For VC investors: their business model is solely based on capital gain and not on dividends, in contrast with traditional private equity funds. Therefore, one should take into account that the possibility for VCs to invest in robust extra-financial reporting is limited by their lack of budget and resources. 

Despite their inherent difficulties, the VCs and startups ecosystem is convinced that innovation should foster the necessary environmental and social transition of our economy. This transformation should be led by investors, whether there are impact by design or generalist entities, and start by the implementation of a robust and harmonized reporting scheme adapted to all market players. The revamped version of the regulation must therefore offer VCs a readable and stable framework for their reporting within the SFDR.

 

Pertinence and limits of the current SFDR scheme for VCs and startups 

Beyond the SFDR implementation, whose objective of improving sustainability performance-related information and comparability to end investors is clearly valuable, the operational impact of the legal requirements is complex to manage for Venture Capital actors which we represent. The European Commission should therefore take into account the following suggestions in any future efforts to reform the SFDR: 

– A more harmonised reporting scheme is highly needed, yet the regulatory framework should be clearer and more consistent to follow. 

– The disclosure requirements should be understood and digestible by all entities and, where appropriate, they should take into account the specific needs of VCs funds investing into SMEs and startups – the latter are not yet profitable and cannot activate and monitor their transition in the same way as mature companies do.

– The legislation should provide a revised definition for “sustainable investments”, which is currently unclear and difficult to implement in regards toArticle 8 and 9. The new definition should better reflect environmental, social and governance impacts, while leaving the discretion to investors of defining their sustainable investment framework. 

– SFDR may better consider social-related impact investee companies, where investment frameworks are very specific, to better reflect them in the future disclosure requirements. This type of investment is often based on a strong dialogue with the entrepreneurs to prove the relevance of their business model with a tailor-made impact assessment based on targeted qualitative social criteria. 

– The legislator should value the work already done by he most advanced funds – notably impact funds aligned with Article 8/Article 9 categories – which have worked (and are still working) extensively on complying  with the current legislation despite its complexity; and should support them in their transition to a new version of the SFDR. 

 

Towards a new standardization for sustainable investments in Europe  

While there are different opinions on a new approach of categorisation, it is essential to create a more flexible scheme for VCs with less constraints if the Commission was to envisage a new standardization scheme. 

If the Commission was to build its reform on the existing Article 8/9 categorisation, it is necessary that it becomes more precise, while  leaving flexibility to the funds to decide their own sustainability investment framework, as VC funds have different investment strategies. 

Otherwise, if the Commission was to create a new categorisation scheme, different parameters could be applied for the VC ecosystem (type of investment approach, new formal product categories, new criteria.. ). For example, we received some detailed proposals to adapt the framework in 4 different categories, with a precise distinction by type of funds: i) sustainability funds, (ii) sustainable impact funds, (iii) transition funds and (iv) traditional funds with minimum reporting requirements). 

To guarantee the effectiveness of a reform of the SFDR, we strongly advocate for a future reporting framework – fully revamped or not – to pay more attention to the size of the investee company. The type of activities should also be taken into account on the reporting needs and how they are calculated. The SFDR remains inadequate for ‘impact by design’ companies, that are more penalised today for the negative externalities of their growth than incentivized for the positive impacts their business model trully generates.