Regulating Greenwashing: Lessons from Europe’s SFDR Framework

Sustainable investing didn’t creep into finance. It arrived quickly and with confidence.

Within a few years, ESG funds were everywhere across Europe. Asset managers updated their brochures. Sustainability teams grew. Climate language moved from the margins of annual reports to the front page of marketing decks.

At first, most people welcomed it. More transparency. More responsibility. More long-term thinking.

But then the awkward questions started to surface.

Investors began noticing that two funds described as “sustainable” could look nothing alike once you checked the holdings. Some carried oil and gas exposure. Others used very different ESG scoring methods. Even professional investors struggled to compare products properly.

The word “sustainable” was being used widely — but not consistently.

That tension is what pushed the issue of greenwashing into the regulatory spotlight.

In financial markets, greenwashing is rarely dramatic. It’s not usually fake projects or invented data. It’s subtler than that. It happens when sustainability claims are technically defensible but hard to verify. When marketing language runs ahead of measurable standards. When disclosures exist, but they aren’t comparable.

By the end of the 2010s, sustainable investing in Europe had grown large enough that this inconsistency mattered. A lot. When billions — and then trillions — of euros are tied to environmental and social claims, the credibility of the entire market depends on clarity.

That’s the backdrop against which the European Union introduced the Sustainable Finance Disclosure Regulation, or SFDR.

The regulation began applying in March 2021. Its aim was not to decide which investments are “good” or “bad.” Instead, it focused on disclosure. If a fund claimed to integrate sustainability risks or pursue sustainable objectives, it had to explain how — in a structured, public way.

On paper, that sounds simple: require transparency, reduce exaggeration.

In reality, things turned out to be more complicated.

Over the past few years, SFDR has changed how European asset managers design, classify and report on their products. It has improved visibility in many areas. But it has also revealed something uncomfortable: defining sustainable investment in practice is harder than it looks.

And that is where the real story begins.

What Is the SFDR Framework?

The Sustainable Finance Disclosure Regulation — or SFDR — is a European Union regulation introduced in 2019 and applied from March 2021.

Its purpose is simple: bring transparency to sustainable investing.

It does not label investments as green. It does not approve funds. It does not certify impact.

Instead, it requires financial institutions to clearly explain how they deal with sustainability.

That includes how they integrate environmental and social risks into decisions, and how they justify sustainability claims in their products.

In short, SFDR regulates what firms must disclose — not what they must invest in.

How Does SFDR Actually Work?

SFDR works at two levels.

First, it looks at the firm itself. Investment companies must explain whether they consider sustainability risks and how those risks affect returns. They must also disclose whether they assess the negative environmental or social impacts of their investments.

Second, it focuses on individual funds.

If a fund claims to promote environmental or social characteristics, or claims to have a sustainable investment objective, it must explain how that claim is measured. It must describe its methodology. It must report regularly.

One of the more detailed elements is the concept of “Principal Adverse Impacts.” This refers to the harmful sustainability effects investments may have — for example, carbon emissions or biodiversity damage. Large firms must publish standardised indicators on these impacts.

The idea is straightforward: if sustainability claims are structured and comparable, greenwashing becomes harder.

Whether that worked perfectly is another story.

Why Did Greenwashing Become a Serious Concern?

By the late 2010s, sustainable investing in Europe was expanding quickly.

ESG funds were attracting serious money. Pension funds were reallocating. Retail investors were asking for climate-aligned products. Asset managers were adjusting strategies to meet demand.

On the surface, this looked like progress.

But if you looked closer, the market felt uneven.

There was no shared definition of what “sustainable” actually meant. One fund would exclude fossil fuels completely. Another would hold energy companies and justify it through engagement strategies. ESG ratings differed sharply depending on the provider. Two funds could both call themselves responsible while investing very differently.

Nothing was necessarily unlawful. But it was inconsistent.

And inconsistency is where greenwashing quietly grows.

Not always through deception. Often through vagueness. Marketing language became broader than the underlying methodology. Investors found it difficult to compare products properly. The label “sustainable” started to stretch.

As money moved into the sector, that ambiguity became harder to ignore.

Why Did the European Union Step In?

At the same time, sustainable finance was becoming politically important.

The European Union was positioning itself as a global climate leader. The European Green Deal was taking shape. Financial markets were expected to support the transition to a lower-carbon economy.

But that ambition required credibility.

If investors cannot trust sustainability claims, capital cannot be directed efficiently. The system loses coherence.

This is the context in which the EU introduced the Sustainable Finance Disclosure Regulation.

SFDR did not try to define “good” or “bad” investments. Instead, it focused on transparency. If a firm claimed sustainability credentials, it had to explain them clearly. If it considered environmental harm, it had to disclose how. If it did not, that too had to be stated publicly.

The logic was straightforward: structured disclosure reduces room for ambiguity.

Whether that logic solved the issue entirely is still debated. But the problem it responded to was clear — a fast-growing, sustainable investment market operating without a common language.

So What Are Article 6, 8 and 9 Funds Really?

This is the part of SFDR that most people outside regulatory circles recognise.

When investors ask, “Is this fund green?”, what they often really mean is: Is it Article 8 or Article 9?

These numbers come directly from the Sustainable Finance Disclosure Regulation. They were written into the regulation as disclosure categories. That’s all they were meant to be.

Article 6 is the default. A fund that does not promote environmental or social characteristics falls here. It still has to explain how sustainability risks are considered, but it does not market itself as sustainable.

Article 8 is different. These funds promote environmental or social characteristics. That might mean screening certain sectors, integrating ESG criteria, or following specific sustainability policies.

Article 9 goes a step further. These funds must have a sustainable investment objective. In theory, this is the most ambitious category under SFDR.

That’s the structure.

But the way the market interpreted it is another story.

Why Did These Categories Create So Much Debate?

Very quickly, investors began using Article 8 and Article 9 as informal labels.

Article 8 became “light green.” Article 9 became “dark green.”

The regulation itself never used those terms. They emerged from the market.

And that’s where the tension started.

Because SFDR is a disclosure framework, not a strict classification system, two Article 8 funds can look very different in practice. One might apply strong exclusions. Another might rely more on ESG scoring and engagement. Both fit within the legal category.

The same applies to Article 9. The definition of “sustainable investment” under SFDR leaves room for interpretation, particularly around what qualifies as doing “no significant harm.”

Over time, some funds originally classified as Article 9 were downgraded to Article 8. That was not necessarily misconduct. It often reflected legal caution as regulators clarified expectations. But it revealed something important: the boundaries were not as sharp as many investors assumed.

This is where the greenwashing debate sharpened.

If investors treat Article numbers as sustainability ratings, but the regulation does not impose uniform portfolio standards, misunderstanding becomes inevitable.

And misunderstanding, even without bad faith, can damage trust.

Has SFDR Actually Reduced Greenwashing?

The short answer is: partly — but not completely.

SFDR has undeniably improved transparency in European markets. Sustainability disclosures are now structured. Asset managers must explain their methodologies. Claims cannot remain vague marketing slogans in the same way they once could.

That alone is progress.

Before SFDR, comparing two ESG funds often meant reading long prospectuses filled with broad commitments. Now, firms must publish pre-contractual disclosures and periodic reports in a standardised format. Larger firms must also report on Principal Adverse Impacts — things like carbon intensity or exposure to controversial sectors.

This creates visibility.

And visibility changes behaviour.

Many asset managers strengthened internal processes after SFDR came into force. Sustainability teams grew. Legal teams became more cautious about claims. Product design became more deliberate. Even fund naming practices came under closer review.

In that sense, SFDR has made careless greenwashing riskier.

But transparency does not automatically equal clarity.

One of the challenges is complexity. The regulation is detailed, and interpreting certain concepts — especially “sustainable investment” and “do no significant harm” — has not always been straightforward. Guidance evolved over time. That created uncertainty in the market.

Another issue is comparability. Even with structured templates, methodologies can differ. Two Article 8 funds may both comply with SFDR while applying very different sustainability thresholds. Investors still need to read carefully.

There is also the perception gap.

Because Article 8 and 9 became shorthand for “how green is this?”, many investors assumed a level of uniformity that the regulation never promised. When media investigations later highlighted holdings in controversial sectors inside some sustainable-labelled funds, the credibility debate intensified.

So has SFDR reduced greenwashing?

It has reduced ambiguity in disclosure. It has increased accountability. It has raised the cost of exaggeration.

But it has not eliminated interpretation differences. Nor has it solved the deeper challenge of defining sustainability in financial markets with perfect precision.

In many ways, SFDR forced the industry to confront a difficult truth: sustainability is not binary. It exists on a spectrum. Regulating that spectrum is inherently complex.

And that complexity is exactly why the conversation around reform — often called “SFDR 2.0” — is now underway.

What Can Other Countries Learn from Europe’s SFDR?

If there’s one thing SFDR shows, it’s this: regulating greenwashing is harder than it looks.

Disclosure helps. It absolutely does. Once sustainability claims become structured and public, the room for vague marketing shrinks. That’s a real achievement.

But Europe’s experience also shows that disclosure alone is not enough.

When categories like Article 8 and 9 are interpreted as quality labels, investors expect clarity that disclosure frameworks don’t always provide. If regulation does not clearly define minimum thresholds, the market will create its own shortcuts — and those shortcuts can distort expectations.

Another lesson is that simplicity matters.

If rules become too complex, even well-intentioned firms struggle with interpretation. That creates legal uncertainty, reclassifications, and reputational risk. For a regulation designed to increase trust, excessive complexity can have the opposite effect.

Finally, enforcement and supervision are as important as the rulebook itself. A disclosure regime only works if regulators actively review claims and challenge inconsistencies.

Europe’s experiment shows progress — but also limits.

Final Thoughts: A Necessary First Draft

It is easy to criticise SFDR.

It is complex. It has been amended. It created confusion around Article classifications. And it did not eliminate controversy.

But it did something important.

It moved sustainability from marketing language into regulated disclosure. It forced asset managers to articulate their methodologies. It signalled that environmental and social claims in financial markets are not optional narratives — they are regulatory commitments.

That shift matters.

No regulatory framework will perfectly define “sustainable.” The concept evolves with science, policy and market practice. What SFDR represents is not a finished solution, but a structural step.

In many ways, it feels less like a final answer and more like a first draft — imperfect, debated, but necessary.

And for a market still learning how to align capital with climate and social goals, that first draft may prove more influential than it initially appears.

Join our upcoming webinar by the Directors’ Institute – World Council of Directors to deepen your understanding of evolving governance and sustainability regulations like SFDR. Gain practical insights into board responsibilities, strengthen your decision-making, and learn how to contribute effectively to higher corporate governance standards.

Register now to secure your spot: - https://www.directors-institute.com/webinar-registration