EU Sustainability: State of Play — ESG in the Financial Services Sector

Our EU Sustainability: State of Play series focuses on regulatory developments and policy initiatives emerging from Brussels. In this series, we explore EU sustainability frameworks and their intersection with other areas of EU law.

EU sustainability regulations continue to play a key role in shaping the direction of international ESG frameworks. Latham’s European ESG Practice tracks these EU-driven developments closely by drawing on our connections with EU regulators, our presence in Brussels, and our broader European platform.

View the full series.

Introduction to the ESG Landscape for Financial Institutions

Sustainable finance sits at the heart of the European ESG framework and underpins the objectives of the European Green Deal. It reflects the process of integrating ESG considerations in investment decision-making, with the aim of increasing investment in sustainable activities. Financial institutions face a wide-ranging and fast-evolving package of ESG-related requirements that operate at both the entity and product levels. From a strategic standpoint, these measures are intended to steer capital towards sustainable economic activities, strengthen the integrity of sustainability claims, and improve the identification, management, and disclosure of ESG-related risks through appropriate governance. Global financial institutions must navigate a patchwork of ESG requirements, stemming from various jurisdictions. This article focuses on the relevant EU regimes.

Initially, EU regulatory attention in the financial services sector has centred on product-level disclosures, in particular under the EU Sustainable Finance Disclosure Regulation (SFDR), to foster trust in sustainability-related products and mitigate greenwashing risk. At the same time, financial institutions are increasingly subject to entity-level transparency and due diligence regimes, including under the EU Corporate Sustainability Reporting Directive (CSRD). For more information on the CSRD and broader EU corporate sustainability regulation, refer to this Latham article.

In this article, we highlight several key EU ESG-related measures relevant to financial institutions, including the SFDR, CSRD, the EU Taxonomy Regulation, and the EU Ratings Regulation.

However, we note that numerous other measures are relevant to financial institutions, such as the European Green Bond Standard (see this Latham article), the integration of sustainability preferences into rules for the distribution of financial products under investment and fund management regimes, labels and disclosure standards for ESG benchmarks, diversity and inclusion requirements for the boards of banking institutions, and expectations around the management of ESG risks within banks.

The Sustainable Finance Disclosure Regulation

Overview: Disclosure Requirements for Financial Market Participants and Advisers

The SFDR sets out mandatory disclosure and transparency requirements for asset managers and certain other financial services firms, at both the entity and product level. The purpose of these requirements is to provide greater information to end investors in order to facilitate informed investment decision-making from a sustainability perspective as part of the wider objective to reorient capital flows towards sustainable investment. The SFDR was introduced as part of a package of measures initiated by the European Commission’s Sustainable Finance Action Plan, which also includes the EU Taxonomy Regulation.

Most provisions of the SFDR have applied since 10 March 2021, with certain elements of the rules introduced on a phased basis. Although the SFDR was finalised pre-Brexit, it has not been adopted in the UK. There is a separate UK Sustainability Disclosure Requirements regime, most of which started to apply during 2024 (see this Latham Client Alert for more detail). However, the UK regime was designed as a product labelling regime, whereas the SFDR was intended to apply as a product disclosure regime.

Scope

The SFDR applies to Financial Market Participants (FMPs) and Financial Advisers (FAs). The definition of FMP encompasses a range of asset managers, including Alternative Investment Fund Managers (AIFMs) and Undertakings for Collective Investment in Transferable Securities (UCITS) management companies, as well as investment firms and credit institutions that carry out portfolio management activities. FAs include firms that provide investment advice, or advice on insurance-based investment products.

Products in scope of the SFDR include investment portfolios, alternative investment funds, UCITS, insurance-based investment products, and certain pension products. The SFDR requires that in-scope products are classified into different categories, depending on their sustainability credentials (see below).

Requirements

Broadly, SFDR requires in-scope entities to:

• make entity-level website disclosures in relation to the integration of sustainability risks in their investment decision‐making process, and investment advice and remuneration polices.
• disclose on their website whether and how the potential adverse impacts of their investment decisions on sustainability factors are considered (note that it is mandatory for certain large FMPs to consider principal adverse impacts).
• classify in-scope financial products based on the environmental and/or social objectives pursued and make certain pre-contractual, periodic, and website disclosures, depending on the classification assigned. Enhanced disclosures apply for Article 8 and Article 9 products.

Notably, the EU Taxonomy Regulation includes separate reporting measures that apply to certain SFDR products, depending on whether the product is classified under Article 6, 8, or 9 of the SFDR. The Level 2 measures under the SFDR provide more detail surrounding the transparency of adverse sustainability impacts, pre-contractual product disclosure, website product disclosure, and product disclosure in periodic reports.

The European Supervisory Authorities have published a consolidated set of questions and answers on the SFDR, which clarify certain key aspects of the regime, such as the definition of “sustainable investment”. This document is updated periodically and is a key source of guidance on the regime.

Review

Various aspects of the SFDR framework have been under review for some time. In particular, the European Commission has published a consultation proposing significant amendments to the SFDR regime to address certain issues that have arisen during the practical application of the SFDR (see this Latham blog post).

This consultation includes potentially changing the SFDR product classifications to move away from the current Article 6, 8, and 9 classifications. The European Supervisory Authorities have published an opinion recommending that the European Commission should replace the current SFDR disclosure framework with either voluntary product categories, sustainability indicators, or a combination of both (see this Latham blog post). This would have a significant impact on the application of the regime and is therefore a key watchpoint. The latest information suggests that the European Commission could publish its proposals on the SFDR in late November 2025.

ESMA Guidelines on Fund Names

In order to address concerns about greenwashing, the European Securities and Markets Authority (ESMA) has issued guidance on fund naming conventions. ESMA’s Guidelines indicate when asset managers may legitimately use ESG or sustainability-related terms in their fund names. ESMA sets the following expectations:

See this Latham blog post for further detail. The Guidelines have applied to new funds since 21 November 2024, and to existing funds from 21 May 2025. When ESMA finalised the Guidelines, it stated that it would reflect on whether to broaden them out to cover other financial products. It has not yet taken any action on this front, but expanding the Guidelines remains a possibility in future.

The Corporate Sustainability Reporting Directive and EU Taxonomy Regulation

There are close ties between the SFDR and both the CSRD and the EU Taxonomy Regulation, as the reporting and disclosure requirements are interlinked. The CSRD builds on and expands pre-existing reporting requirements under the Non-Financial Reporting Directive, and brings more entities into scope. The CSRD is characterised by its broad reporting requirements (it covers the entire spectrum of sustainability topics, and includes a so-called “double materiality” assessment, requiring entities to assess both financial materiality and impact materiality) and extraterritorial impact (many non-EU financial institutions find themselves in scope, either directly as the regime captures certain non-EU entities, or as part of their parent entity’s requirements). The extraterritorial impact is proving particularly difficult for global financial groups to navigate.

Implementation has been uneven, with several Member States yet to fully transpose the CSRD into national law. Further, shortly after the first wave of reporting began in early 2025, the European Commission published its first Omnibus Package on sustainability. Measures to delay CSRD reporting requirements for certain companies have been passed, while more detailed proposals seeking to amend the CSRD more substantially are progressing through the legislative process. Therefore, significant uncertainty remains regarding the ultimate shape of this regime. For more detail on the CSRD and the potential impact of the Omnibus proposals, please see this Latham article.

The EU Taxonomy provides a classification system for sustainable economic activities across six environmental objectives, allowing investors and other market actors to understand which activities (and therefore, which financial products) are deemed to be sustainable, according to objective criteria. It aims to provide consistent, technical definitions to direct private capital towards green investments.

The Taxonomy integrates with other pillars of the sustainable finance framework; and there are two key examples of how it is relevant to financial institutions. First, those required to report under the CSRD will need to report the percentage of their activities that are Taxonomy-aligned. Second, under the SFDR, Taxonomy-aligned activities are included in the definition of “sustainable investment”, which is relevant to Article 8 and 9 products. Consequently, Article 8 and 9 funds must disclose how and to what extent the underlying investments are Taxonomy-aligned.

Elements of the Taxonomy are being reviewed under the Omnibus Package. Proposals include making Taxonomy reporting voluntary for certain entities, and exempting activities that account for less than 10% of turnover from detailed reporting requirements. For more detail on the EU Taxonomy and the potential impact of the Omnibus proposals, please see this Latham article.

ESG Ratings Regulation

Overview: Enhancing Transparency of ESG Ratings Activities

The EU ESG Ratings Regulation (ERR) is a key new part of the EU’s sustainable finance landscape. It aims to strengthen the quality and reliability of ESG ratings in response to concerns that, while such ratings are becoming increasingly important as the market for sustainability-related financial products develops, there are few controls around how they are produced. The EU has spent the last several years developing this new framework, which will take effect on 2 July 2026. Please also see this Latham Client Alert on the regime. At present, ESMA is working on some of the Level 2 measures under the ERR relating to authorisation requirements, separation of activities, and disclosures, and expects to publish a Final Report by the end of 2025. However, a recent publication by the European Commission indicates that it is de-prioritising several of the Level 2 measures under the ERR that it considers non-essential. It has stated that it will not adopt these acts before 1 October 2027, meaning that affected entities may need to make independent judgements about how best to comply with certain obligations under the ERR.

The UK is also planning to introduce a new regulatory regime for ESG rating providers, along similar lines to the ERR. The legislation is expected be finalised before the end of 2025, after which the Financial Conduct Authority will need to consult on regulatory rules for the regime. Therefore, some time will pass before the UK regime begins to apply. For more detail, see this Latham blog post.

Scope

The ERR applies to the provision of an ESG rating by an ESG rating provider operating in the EU. Key definitions under the ERR include:

A rating provider aiming to be operating in the EU needs to be established in the EU and either:

• Issue and publish ratings on the provider’s website or through other means; or
• Issue and distribute ratings through subscription or other contractual relationships to:
• regulated financial services firms in the EU;
• entities within scope of the EU Accounting Directive or EU Transparency Directive; or
• certain EU bodies, or public authorities in an EU Member State.

Rating providers established outside the EU will only be in scope of the ERR if they fall within the second bullet above (i.e., they are issuing or distributing ratings to relevant EU entities through subscription or other contractual relationships). This helpfully limits the scope of the ERR by ensuring that overseas rating providers are only caught if they are actively and purposefully providing their services in the EU.

There are a number of exemptions under the ERR, designed to keep the regime proportionate. These include exemptions for ratings provided for internal purposes, ratings issued by regulated financial institutions, SFDR and EU Taxonomy disclosures, ESG labels, and products or services that incorporate an element of an ESG rating, such as investment research.

Requirements

EU entities falling in scope of the ERR will need to apply to ESMA for authorisation as an ESG rating provider. ESMA has indicated that existing ESG rating providers will have to notify it of their intention to continue offering ESG rating services in the EU by 2 August 2026. They will then need to apply for authorisation by 2 November 2026. Small ESG rating providers will have access to a temporary lighter-touch regime, which will run for three years.

Non-EU entities in scope of the ERR will only be able to provide ratings in the EU by utilising one of three access routes: equivalence, endorsement, or recognition. These are borrowed from the EU Benchmarks Regulation and have proved difficult to utilise in practice under that regime.

ESG rating providers operating in the EU will need to comply with organisational requirements that govern the integrity and reliability of ESG rating activities. This includes the maintenance of a permanent, independent, and effective oversight function to ensure oversight of all aspects of the provision of their ESG ratings. ESG rating providers will also be restricted from providing certain other services that could conflict with the delivery of ESG ratings, such as the provision of credit ratings.

Further, providers will be subject to detailed disclosure rules concerning their ratings. For example, they will need to disclose whether E, S, or G factors are taken into account (or an aggregation of these factors) and the rating given to each relevant factor; the weighting each of these factors is given in the aggregation. Providers will also need to disclose details of the limitations of the information available to them, including information about engagement with the various stakeholders of a rated entity and how contradictory, incomplete, or subjective information is handled.

Conclusion and Outlook

Against this backdrop, the regulatory landscape for sustainable finance remains in flux. Core frameworks such as the SFDR, CSRD, and the EU Taxonomy Regulation are either being refined, partially deferred, or reconsidered altogether, while supervisory guidance continues to evolve in parallel. For financial institutions, this means operating through a prolonged period of regulatory change, and shifting regulatory expectations.

In practical terms, firms should anticipate continued adjustments to the framework, accompanied by potentially uneven implementation across Member States and divergence with the UK and other jurisdictions. This complexity heightens the risks associated with product design, disclosures, and group-wide reporting. While uncertainty is unlikely to abate in the short term, it is hoped that the changes on the horizon will result in more coherent, impactful, and proportionate regimes. Latham & Watkins will continue to monitor developments closely.

Latham's European ESG and Financial Regulatory practices have experience advising on a broad range of EU and global sustainability topics, as they relate to financial institutions. Should you have any questions or would like further information on any of these topics, contact one of the authors below, or another member of your Latham & Watkins team.