Europe’s top ESG fund class may be close to reaching a tipping point.
Known as Article 9, the designation may be stripped from hundreds of funds in the coming months, industry estimates show. There are now signs that investment clients are starting to retreat, as fresh data points to a marked slowdown in flows. And on Thursday, a report indicated that some Article 9 funds hold assets that may violate UN and OECD standards on everything from bribery to environmental damage.
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Many fund managers “are trying their best and have spent millions on legal fees to ensure they take the right approach,” but “outcomes won’t be coherent across the industry” and that “creates systemic risks,” said Hugo Gallagher, senior policy adviser at the European Sustainable Investment Forum, whose members represent about $20 trillion in assets under management.
It’s a development that exposes gaps in an ESG regulatory framework once hailed as the world’s most ambitious. Since the Sustainable Finance Disclosures Regulation was enforced in March 2021, the EU has had to provide several clarifications. These include telling the industry that all Article 9 funds must be entirely sustainable, with some allowances for hedging and liquidity.
A study by Clarity AI found that close to 20% of the 750 Article 9 funds it analyzed have more than 10% exposure to companies “that have violations” of United Nations Global Compact principles or the OECD Guidelines for multinational enterprises. Its research also shows that 40% of the funds studied have more than a 5% exposure to such violations.
“The classification of funds according to the SFDR guidelines is increasingly used by fund providers as a shorthand for communicating that a product is sustainable,” Clarity AI said in the report, which was compiled by a team led by Patricia Pina, the firm’s head of product research and innovation.
“However, our analysis shows that some of the Article 9 funds currently in the market might be falling short of complying with the do-no-significant-harm criteria as defined by the regulation,” the authors wrote.
Alexander Stafford, chairman of the UK parliamentary group on ESG, said the Clarity AI report highlights “flaws in the EU’s ESG instruments and regulatory framework,” and added that the UK government now “has its work cut out” to avoid falling into similar traps as it designs its own ESG investing rules.
The report followed a study last week by Morningstar which found that less than 5% of funds meet the EU’s requirements of holding only sustainable assets. Morningstar also noted that some asset managers are taking a “surprisingly” lax approach toward Article 9, with 43% of funds analyzed targeting a sustainable-asset threshold of less than 50%.
Now, “asset managers wishing to avoid greenwashing accusations seem to be downgrading,” said Lara Cuvelier, a campaigner at environmental nonprofit Reclaim Finance. “National regulators will have to take up the issue and define red lines for what should not be in a ‘sustainable’ fund. Minimum standards are needed.”
Read the full article here by Frances Schwartzkopff, Greg Ritchie, Advisor Perspectives.
