Take a step back – ESG Investor (2023)

Some ESG funds are abandoning their Article 9 “deep green” label.

In a rapidly changing world, new words and the concepts they describe seem to emerge at a bewildering rate. One of these, unprecedented a few years ago, is “greenwashing,” the practice of camouflaging products, services or investments to make them fully compliant with ESG principles, contrary to underlying reality.

The lack of consistent definitions of what constitutes ESG investing has made it difficult to spot greenwashing in a world where sustainable or responsible investing can be seen as something in the eye of the beholder.

Ironically, this has been given a new twist by a movement aiming to bring some order to the world of ESG investing, the European Union.Sustainable Finance Disclosure Regulation(SFDR), the main provisions of which came into force in March 2021. Among other things, the SFDR created two categories of ESG funds, Article 8 and Article 9.

Resources from the first segment are needed to promote environmental or social attributes and to invest in companies with good governance, while the last resources are needed to generate positive environmental or social impacts by explicitly pursuing sustainability goals.

First, there was a rush towards funds classifying themselves as Article 9 to better capitalize on increased demand for green label financial products from both retail and institutional clients. More recently, however, there has been a move in the opposite direction, with some managers reclassifying their products into Article 8, the so-called light green category.

What's wrong?

Deep green loses some of its attractiveness

In a word, scrutiny: by regulators, some investors, and independent researchers. In May this year, the European Securities and Markets Authority (ESMA) published amonitoring informationwith the result that the SFDR settings were tightened. Travers Smith, a law firm, noted that one of the regulator's key objectives is to "reverse greenwashing," citing the guidance: "Sustainable investment policies and/or objectives should be incorporated into the fund and fund documentation. It should be managed accordingly."

The guidelines further state: “Any investment strategy that supports the sustainable investment policy and/or the sustainable investment objectives must be disclosed to investors, with an explanation of how this strategy relates to the sustainable investment policy and/or the sustainable investment objectives.” .

ESMA's guidance will be interpreted as requiring that all investments made by an Article 9 fund support its sustainability objectives.

He explained that national regulators in Europe will use the new guidance “primarily when examining fund documents (such as prospectuses and private placement memorandums); for example, when a company applies to an EU regulator for a marketing pass or registers with one of the many national EU private placement schemes that involve some element of essential document verification. It is also possible that some regulators also conduct regular thematic reviews of the practices of individual companies.”

The upshot of all this is that Article 9, the dark green category of the gold standard, has lost some of its appeal.

act in good faith

According to Morningstar, the fund's data and analytics provider, there have been 16 such downgrades from Article 9 to Article 8second quarter of this year, and observers believe moving away from Article 9 could gain more traction.

Hortense Bioy, Morningstar's Head of Sustainability Research, said: "New guidance at EU and national level (the Netherlands being an example) has led some asset managers to downgrade their funding from Article 9 to Article 8 Category of Article 9. We can expect to see more of this until the process is completed.

"There has to be a limit to the size of the discounts, but I don't know what it is."

Hugo Gallagher, senior policy adviser at Eurosif, a pan-European organization representing providers of sustainable financial services, pointed the finger at the vagueness of Article 9's definitions, even under ESMA's new guidance. “It might be a little strong to say that companies are afraid of being accused of greenwashing. This may be a factor, but the real problem is the difficulty of defining sustainable investing. The definition of Article 9 is not precise and asset managers have been left to their own devices in interpreting it.

“This creates uneasiness in the market as no two definitions of sustainable investing are the same. Many wealth managers act in good faith but are concerned that their clients do not share their definition of sustainable investing and that it is inconsistent with that of other financial market participants.”

Morningstar's Q2 2022 survey underscores the diversity of interpretations among managers. While more than half of the Article 9 funds had allocations for sustainable investments greater than 70%, 40% had allocations less than 50% of the fund and only 2.3% had allocations greater than 90%.

At the European Fund and Asset Management Association (EFAMA), Vincent Ingham, Director of Regulatory Policy, sees the benefits of tightening the guidelines. “Wealth managers continue to have high demand for sustainable investing, particularly from institutional investors and mandates, so this remains a strong growth area for them.

second estimator

“The Article 9 to 8 fund reclassifications are primarily the result of continued regulatory guidance from the European Commission and national regulators, which have provided greater clarity. As companies adapt to the updated ruleset, this is a positive development for the industry,” said Ingham.

"Given the current lack of clear labeling standards, SFDR disclosure ratings are often used as an indication of a fund's ESG credentials, but that's not what they were designed for."

While some managers exercise discretionary claims they can no longer support, others are doubling down in light of the new guidance.

Morningstar's Bioy noted: "Some money managers prefer to take the other route, trying to avoid a downgrade and looking for strategies that allow them to stay in the Article 9 classification. But it's very difficult to meet the criteria of Article 9. Wanting Article 9 To have 100% sustainable investments, we need a methodology to get us there.”

A study of European ESG models for around 6,000 Article 9 funds and share classes found that only 79 had set 100% as the minimum level for sustainable investing, while 168 had set a minimum of 90% and the vast majority left the blank. According to FE fundinfo, which conducted the analysis, even if these no-minimum funds end up with almost 100% sustainable investments, “this means that there are still at least 1,500 funds that need to review their Article 9 status”.

Eurosif's Gallagher believes the very strict criteria for Article 9 classification are partly behind the change. In this context, it is unrealistic to require Article 9 funds to invest exclusively in 'sustainable investments'. Article 8 is more convenient for them. Many Article 9 funds are considering reclassification to Article 8, which offers more flexibility and less potential for regulatory action. You can still have a very ambitious fund within Article 8.”

Another reason for the reclassification from Article 9 to Article 8 may be the forthcoming introduction of so-called SFDR Level 2 requirements. Originally scheduled for early this year, they are nowpostponed to January 2023.

Under Tier 2, Section 9 funds are required to report their environmental objectives to highlight how they have impacted the environment, while Section 8 products are subject to pre-contractual and periodic disclosures for less polluting products.

The actions of the USA have consequences

Should the industry do more to track dubious ESG claims? Ingham says: “At EFAMA we work closely with our members, regulators and other stakeholders to promote a regulatory framework that eliminates the risk of 'greenwashing' as much as possible and ensures there is clarity and accountability for everyone in the industry chain there. . from corporates to wealth managers, distributors and investors.

Greenwashing is by no means an exclusively European problem. In May, the US regulator, the Securities and Exchange Commission (SEC), released two proposals to address the issue. According to the Commission, the first set of changes should “enable better disclosure of ESG issues to customers and shareholders”.

The proposed changes aim to "create a consistent, comparable and actionable regulatory framework for ESG advisory services and investment firms to inform and protect investors and facilitate further innovation in this area as the wealth management industry evolves."

The second brings the fund's content closer to its description and increases investor protection "by improving and clarifying the requirement that certain funds pursue an investment policy of at least 80% of their assets in accordance with the investment approach of the fund that the name suggests , tracked". .

These changes, as a result of coercive measures againstDWShave had an impact on this side of the Atlantic, among others, where sustainable investments have a larger market share. In the second quarter of 2022, the assets of Article 8 and Article 9 funds accounted for more than half of the European investment market, although collective assets 9 fell by 6.4% to €4.18 trillion at the end of June.

A UK market source said the SEC's moves meant some administrators had reconsidered their Article 9 classification, adding: "The main benefit of a reclassification is that there is no minimum requirement under Article 8 for the investment to be made. sustainable, but there is still an opportunity to promote the ESG characteristics of the fund.”

[This story was updated on 09/15/2022 to remove a reference to information reported in a Bloomberg story that is no longer accurate.]