The European Commission has pledged to simplify regulations for sustainable funds this year. Frédéric Vonner, sustainability expert at PwC Luxembourg, hopes that transition investments will gain more recognition in the process.
With the maze of abbreviations—from SFDR and CSRD to CSDDD—it is easy to get lost in the European labyrinth of sustainable fund regulations. European Commission President Ursula von der Leyen has already admitted that the system is overly complex and promised at the end of last year to streamline all ESG regulations. This should lead to a unified legal framework and a clear classification system.
This reform cannot come soon enough for Frédéric Vonner, who closely follows these issues as a consultant. Despite the excessive bureaucracy, investors still frequently encounter greenwashing.
“Some funds take an easy approach towards sustainability. There are funds that don’t disclose upfront what they do or what their actual sustainability ambition is, to limit the risk of not delivering on these. We have also seen as many definitions of sustainable investments as there are asset managers, or almost. Fund creators have certainly not lacked creativity in giving their funds some sustainable features.”
However, improvements appear to be on the horizon. To combat greenwashing, the regulator Esma introduced guidelines at the end of last year for ESG or sustainability-related terms in fund names, such as “sustainable”, “transition”, or “impact”. This should bring more consistency to fund names. “The Esma rules are a step in the right direction,” Vonner believed.
Nutri-score
A simplified and clearer classification system could provide even more clarity for investors. The current SFDR (Sustainable Finance Disclosure Regulation) refers to Article 6 investment products (no sustainability features), Article 8 investment products (which include ESG characteristics), and Article 9 investment products (with measurable ESG objectives).
However, the sustainability criteria for Article 8 are so weak that they are hardly distinctive. Vonner explained: “Disclosing under the Article 8 essentially means nothing. All it takes is excluding gambling companies from your fund, and you might qualify. Asset managers have cleverly used and even misused the SFDR classification. What was originally designed as a disclosure tool has been used as a sustainability label.”
Virtually every expert agrees that a new classification system is needed that better reflects the sustainability level of a fund and is easily understandable for investors. Some refer to the Nutri-Score for food products or the eco-labels for refrigerators and washing machines.
However, adapting such ranking systems to investment funds is easier said than done. “ESG is so broad that I am not sure we will ever find a simple method. You already have three dimensions: E (environmental), S (social), and G (governance). Should each fund receive three separate ‘Nutri-Scores’? Or should the ESG score be composed of three individual scores: an environmental score, a social score, and a governance score? You can immediately see how complicated this can become.”
Taxonomy
One potential simplification would be to use the EU Taxonomy—the EU’s classification system for sustainable activities—as a benchmark for “dark green” Article 9 funds, Vonner suggests.
“This would lead to more coherence within European financial regulations. But only on the condition that the Taxonomy is revised. Currently, the Taxonomy views everything in black-and-white terms: an investment is either sustainable or not. As a result, transition investments are overlooked. In transition investing, the underlying activity is not sustainable at the outset but becomes so over time. It seems crucial to me that we direct capital flows precisely towards such transition investments. This dynamic dimension is currently missing from the Taxonomy.”
Another obstacle to a unified European approach is that sustainability is interpreted differently in each country, with nuclear energy being the most well-known point of contention: the French are highly enthusiastic about it, whereas the Germans reject it entirely. “But perhaps we do not even need such a standardised system, like the Nutri-Score. Where we will ultimately end up remains an open question today.”
Does Vonner ever tire of the many definitions and sometimes divergent approaches to sustainable investing? “Actually, I am not so pessimistic about it,” he responded. “Compare it to five or ten years ago: back then, there was nothing at all. While things are still far from perfect, the objective is clear: to provide investors with accurate information about the sustainability features of funds so that they can compare and make well-informed investment choices. We will not reach the final destination overnight, but it will be achieved through many small steps.”