EU Sustainable Finance: Council Agrees Negotiating Mandate for SFDR 2.0 — Key Suggested Amendments for Financial Market Participants

On 24 June 2026, the EU Council published its negotiating mandate for the proposed comprehensive amendment to the Sustainable Finance Disclosure Regulation (SFDR 2.0). Under the EU’s ordinary legislative procedure, a Commission proposal must be agreed upon by both the European Parliament and the Council before it can become law. The Council’s mandate sets out the Council’s negotiating position for upcoming trilogue negotiations with the Parliament but does not represent a final or agreed upon text. The European Parliament is separately developing its own position, and the final legislation will only emerge from trilogue negotiations between all three institutions—a process that may result in further significant changes. As detailed in our previous Client Alert from 2 December 2025, the EU Commission’s original proposal introduced a new three-category product classification system (Transition, ESG Basics, and Sustainable), replacing the current framework in Articles 8 and 9.

The Council broadly supports the Commission’s approach but proposes a number of targeted calibrations. In this follow-up Client Alert, we outline the key amendments put forward by the Council and explain what they would mean for financial market participants (FMPs) if retained in the final legislation, specifically:

• A more prescriptive approach to mandatory principal adverse impact (PAI) indicator disclosures for the Transition and Sustainable categories, requiring use of at least three indicators from a Commission-developed list;
• A carve-in allowing fossil fuel companies to qualify for the Transition category, subject to capital expenditure and emissions reduction conditions;
• A new pathway for general-purpose EU public-sector bonds to count toward the 70% contribution threshold in the Transition category, capped at 15 percentage points;
• An opt-out from the categorization regime for alternative investment funds (AIFs) offered exclusively to professional investors;
• A three-year cap on the phase-in period for meeting the 70% investment threshold; and
• An extended application period of 24 months (instead of 18) after entry into force.

As the text remains subject to trilogue negotiations, these provisions may be modified or removed before SFDR 2.0 is finalized.

In the meantime, FMPs should:

• Continue to comply with the current SFDR regime;
• Monitor the key fault lines between the Council and anticipated Parliament positions;
• Begin assessing which of the three categories their current products might fall into; and
• Conduct a preliminary evaluation of the practical implications of the Council’s proposals for their specific product lines. 

1. Council Retains the Three-Category Framework—with Targeted Adjustments

The Council confirms the creation of three categories for products making sustainability-related claims, which are to set up a clear system according to which sustainability-related financial products should be clustered. The three categories—Transition (Article 7), ESG Basics (Article 8), and Sustainable (Article 9)—remain broadly as proposed by the Commission. The Sustainable category covers products claiming to invest in companies, assets, activities, or projects that are already sustainable or pursue a particular objective related to sustainability factors. The Transition category covers products claiming to invest in companies on a credible path to sustainability. The ESG Basics category covers products claiming to integrate other sustainability considerations beyond sustainability risks.

However, the Council proposes important targeted changes in five key areas.

2. Mandatory PAI Indicators—More Prescriptive Approach

One of the most significant changes concerns the PAI disclosure requirements for products in the Transition and Sustainable categories.

Commission proposal: FMPs are required to identify and disclose PAIs and explain the actions taken to address those impacts. For their PAI disclosures they may use appropriate sustainability-related indicators.

Council amendment: For the purpose of PAI disclosures under the Transition category, FMPs shall use at least three indicators listed in the delegated act to be adopted by the Commission which are most relevant to the transition-related objective(s) of the financial product. Where FMPs demonstrate that none of those indicators are relevant to the financial product, they may use alternative sustainability-related indicators. The same approach applies to the Sustainable category, where FMPs shall use at least three indicators referred to in the delegated act which are most relevant to the sustainability-related objective(s) of the financial product.

What this means: The Council is replacing the broad discretion FMPs had in choosing how to disclose PAIs with a more prescriptive, harmonized approach. This should improve comparability across products but will require FMPs to align their PAI reporting with a specific list of indicators to be developed by the Commission.

3. Fossil Fuel Exclusions—Carve-in for Transition Category

The treatment of fossil fuel-linked companies in the Transition category is one of the most closely watched aspects of the Council’s position.

Commission proposal: Products cannot invest in certain industries or activities that are considered incompatible with the category, including for the Transition category companies that “develop new projects for the exploration, extraction, distribution, or refining of hard coal and lignite, oil fuels, or gaseous fuels.”

Council amendment: The Council provides that the Transition category shall exclude investments in companies that derive revenue from the exploration, extraction, mining, or refining of hard coal and lignite, oil fuels, or gaseous fuels, except where such companies (i) allocate at least 20% of total capital expenditures to Taxonomy-aligned economic activities, and (ii) have in place a time-bound and measurable strategy to reduce their Scope 1 and Scope 2 greenhouse gas emissions compatible with the limiting of global warming in line with the Paris Agreement.

For financial products that include investments in companies that derive revenue from the exploration, extraction, mining or refining of hard coal and lignite, oil fuels, or gaseous fuels, FMPs shall, in addition to the three mandatory indicators, use an additional indicator on the proportion of investments in companies active in those sectors.

What this means: Fossil fuel companies are not automatically locked out of the Transition category, provided they demonstrate a meaningful commitment to the transition. This seems to have been added in recognition of the role of transition finance in the real economy, but comes with enhanced transparency requirements (a fourth mandatory PAI indicator).

4. Treatment of Public-Sector Bonds—New Pathway for Transition Category

The treatment of sovereign and public-sector debt is significantly recalibrated.

Commission proposal: Under the Commission’s proposal, each of the three product categories requires that at least 70% of a product’s investments follow an ESG strategy aligned with the relevant sustainability claim. This means that a minimum of 70% of the portfolio must be invested in assets that contribute to the product’s stated sustainability or transition objective. The remaining 30% may be freely allocated for diversification, hedging, or liquidity purposes; provided those investments do not contradict the product’s sustainability claims. General-purpose sovereign bonds, including those issued by EU Member States, were broadly excluded from counting toward this 70% contribution threshold because the framework’s assessment criteria are designed around company-level transition plans and sustainability metrics that cannot be readily applied to sovereign issuers whose bond proceeds flow into the general government budget rather than earmarked sustainability projects.

Council amendment: The Council establishes a targeted eligibility pathway for general-purpose issuances by public-sector bodies established in the Union—i.e., EU Member States and EU-level public bodies—under which those issuances may count towards the contribution threshold under the Transition category provided that the FMP demonstrates, based on formalized and documented methodologies, that such investment is aligned with the financial product’s transition-related objective(s) and that these investments do not represent more than 15% of the portfolio.

For the ESG Basics category, FMPs may also count investments in general-purpose debt issuances by public-sector bodies toward the contribution threshold, using available methodologies that are appropriate to assess the sustainability of those investments.

What this means: This change is particularly important for insurance and pension products, where sovereign debt makes up a large share of the portfolio. Under the Commission’s original proposal, these general-purpose government bonds could not count toward the 70% threshold, making it difficult for such products to qualify for the Transition category—even if they otherwise pursued a genuine transition strategy. The Council now allows these bonds to count, but only up to 15 percentage points of the 70% threshold, and only where the FMP can demonstrate alignment with the product’s transition objective using a documented methodology. In other words, sovereign bonds can help fill the gap, but they cannot be the main driver of a product’s transition credentials. Notably, the Council restricts this pathway to public-sector bodies established in the Union because all EU Member States are bound by common climate and sustainability commitments at the Union level, including the European Climate Law (Regulation (EU) 2021/1119), which requires climate neutrality by 2050, and the EU’s commitments under the Paris Agreement, providing a meaningful and verifiable baseline for assessing whether such issuances are aligned with a product’s transition objectives. Non-EU sovereign issuers do not benefit from this pathway, as they are not subject to the same binding EU-level commitments.

5. AIF Opt-Out for Professional Investors — A Key Development

The Council reintroduces an exemption for AIFs offered exclusively to professional investors.

Commission proposal: An exemption from the mandatory product categorization regime would apply to closed-ended funds that are no longer open to new investments at the time when SFDR 2.0 enters into force. Unlike a previously leaked Commission draft, this exemption would not apply to AIFs.

Council amendment: FMPs may choose not to apply the categorization provisions (Articles 6a, 7, 8, 9 and 13(3)) to financial products referred to in point (b) of Article 2(12)—i.e., AIFs—which are made available exclusively to professional clients referred to in Section I of Annex II of Directive 2014/65/EU. The rationale is that information asymmetries are less likely to manifest where AIFs are offered exclusively to professional investors. To that effect, those FMPs must ensure that their own distribution arrangements target only professional clients with respect to relevant financial products.

What this means: This is a significant development for private markets. FMPs managing AIFs for professional-only investors could opt out of the entire categorization regime, including naming and marketing restrictions. However, as several commentators have noted, this opt-out comes with practical considerations:

• Institutional limited partners (e.g., pension schemes and insurers) may still demand SFDR-equivalent disclosures for their own regulatory or reporting purposes;
• Funds that may in the future be opened up to retail investors, or that sit within broader fund structures that also serve retail investors, will need to carefully consider whether making use of the opt-out is appropriate in their circumstances; and
• General marketing standards (i.e., clear, fair, and not misleading) continue to apply regardless.

6. Phase-in Period for the 70% Threshold—Three-Year Cap

The Council introduces a concrete time limit for the ramp-up of investment portfolios to meet the 70% threshold.

Commission proposal: The Commission acknowledged that implementing investment strategies takes time but did not specify a maximum phase-in period.

Council amendment: The percentage should be reached at the latest at the expiry of the phase-in period and should not exceed three years, without prejudice to any shorter or longer specific phase-in periods provided under the Union sectoral legislation applicable to that financial product. The phase-in period shall be reflected in pre-contractual disclosures.

What this means: This provides welcome clarity for the market. However, the three-year cap may pose challenges for certain fund types—in particular, private equity, infrastructure, and real asset funds—where it is common for capital to be deployed gradually over a period that exceeds three years. FMPs managing such products will need to monitor whether applicable sectoral legislation provides for a longer phase-in period, and how this provision develops during trilogue negotiations.

7. Extended Application Period—24 Months Instead of 18

Commission proposal: SFDR 2.0 will apply 18 months after its entry into force.

Council amendment: The Council proposes that SFDR 2.0 shall apply from 24 months after entry into force.

What this means: The additional six months should provide FMPs with more time to prepare for the new regime, in light of the significant categorization, disclosure, and operational changes.

What Should FMPs Do Now and What Is Coming Next?

The Council’s position is an important step, but it is not the final text. In the European Parliament, the Committee on Economic and Monetary Affairs (ECON) has the lead responsibility, with a draft report presented in ECON on 3 June and a vote on amendments scheduled for mid-July. Trilogue negotiations between the Council, Parliament, and Commission are expected to begin in early Q4 2026 once the Parliament adopts its own position.                                

FMPs should:

• Continue to comply with the current SFDR regime, which remains in force until SFDR 2.0 is finalized and applies;
• Monitor the key fault lines between the Council and anticipated Parliament positions, particularly on the AIF opt-out and fossil fuel treatment, which are likely to be central trilogue issues;
• Begin preparing for the new categorization regime by assessing which of the three categories their current product range might fall into and identifying potential gaps; and
• Assess the practical implications of the Council’s proposals on phase-in periods, PAI indicators, and data disclosure requirements for their specific product lines.