Over the past decade, sustainable and ESG investing has grown rapidly. At the same time, concerns about greenwashing, the exaggeration of environmental or social benefits of financial products, have increased just as quickly. A growing body of research suggests that many sustainable investments have limited real-world impact, and in some cases may even be counterproductive.

In response, regulators have increasingly turned to disclosure-based regulation. The idea is appealing: rather than restricting investment choices, regulators can require standardized transparency, allowing investors to discipline markets themselves.

One of the most ambitious disclosure regimes to date is the European Union’s Sustainable Finance Disclosure Regulation (SFDR). Introduced in March 2021, SFDR requires mutual funds to classify themselves into three categories: Article 6 funds with no sustainability focus, Article 8 funds that promote environmental or social characteristics, and Article 9 funds that pursue a sustainable investment objective.

In our recent NBER working paper, we study whether SFDR achieved its core objectives. Did the regulation affect investor behavior? Did it lead funds to become more sustainable? And what lessons does it offer for the design of future ESG regulation?

What Must Happen for Disclosure to Matter

For sustainability disclosure to affect real economic outcomes, several steps must occur. First, funds labeled as more sustainable must actually differ in their underlying portfolios. Second, the disclosures must convey new or clearer information to investors. Third, investors must respond by reallocating capital based on that information.

Only if all three steps occur can disclosure-based regulation possibly influence asset prices and, ultimately, firms’ real-world behavior.

Our analysis evaluates each of these channels. (more…)