There is still a pervasive misconception that articles 8 and 9 of the SFDR represent ESG labelling benchmarks. Similarly, there is a belief that declaring a fund as article 6 gives greater latitude to continue as if SFDR hadn’t happened. Failure to understand these requirements could expose asset managers to reporting and greenwashing risks, not least with the sustainability preferences aspects of MiFID II coming down the pike.
According to one recent headline in the financial press: “SFDR Article 8 fund label questionable in 20% of cases, analysis suggests.” Another talked of SFDR allowing funds to “market themselves as either Article 8, which means fully or partly focused on environmental, social or sustainability issues, or a more stringent Article 9, which means fully focused on sustainable objectives.” The assumptions behind these comments appear to misunderstand the thrust of the regulation.
What Articles 6, 8, 9 mean
“SFDR has been very often seen by some as a product classification and even as a product-labelling initiative, both of which are absolutely not the case,” said Nathalie Dogniez, a partner with PwC Luxembourg. “SFDR is about transparency, so that the investor can understand the extent of promises made and the processes that have to be implemented to achieve these goals,” she explained.
Hence Article 8 funds should promote “environmental or social characteristics,” Article 9 is for funds “where a financial product has sustainable investment as its objective.” Making these declarations makes no claim about the extent of compliance with sustainability goals. This comes with alignment with ESG investing taxonomies. Extra credibility comes from approval by labelling agencies which set benchmarks and conduct audits to ensure compliance.
“Another very common misunderstanding or language misuse is how article 6 funds are referred to,” Dogniez adds. “Article 6 of SFDR is about giving transparency over how ESG risks are being managed, and so applies to all funds, including those that promote environmental/social characteristics (article 8) and those pursuing sustainability objectives (article 9) as well as all the funds with no sustainability promises.”
No short cut
It would be risky if marketing material, reports or distribution partners make false claims on this basis. It is also incorrect to believe that by declaring a fund as not being article 8 or article 9 gives freedom to report relatively freely. Most investments might have no explicit ESG goals, but the asset manager might like to point out that one or other investment has sustainability characteristics. This too is a false notion.
“Some asset managers believe it is less risky to declare funds not being article 8 or article 9 as they are concerned that this would lead to additional requirements at a later date,” Dogniez said. Yet the European Commission has stated that “as soon as your product gives the impression that it is promoting environmental and social characteristics, the way you communicate about it should be aligned with SFDR requirements, normally for article eight,” she added.
MiFID II: the test
These strategies and their implementation are to be tested later this year with the implementation of sustainability preferences within MiFID II, probably in August. This will check whether the client understands the extent of compliance of each product and whether this meets their expectations. “There are three major components,” said Dogniez, “explaining the minimum percentage of taxonomy alignment, specifying the minimum percentage of sustainability investment in a particular product, and the consideration of principle adverse impact indicators.” The most obvious example of the latter relates to measurements of greenhouse gas emissions.
A difficulty with this, of course, is that the taxonomy is still in its infancy, with Dogniez saying only around 90 activities are currently covered, relating mostly to climate change mitigation and adaptation. As well, data is lacking, with asset managers often having to source this themselves, both in terms of an assessment of green objectives and the “do no significant harm” criteria.
Long wait for third-party data
Dogniez says the industry is unlikely to see the emergence of reliable centralised third party ESG databases before the middle of the decade at the earliest. “I would guess that it won’t be until 2025/2026 before we are in the building phase of having centralised data available, and a few more years before it is complete and fully operational in Europe, and even longer on a global level,” she said.
Another concern is regarding investor expectations on taxonomy alignment. Even if the data is available, achieving levels such as a quarter or one-third of investments being aligned is a substantial achievement. At the recent ALFI conference, Eric Borremans, Head of ESG at Pictet Asset Management was proud to announce that one of their funds was nearly 30% aligned with the taxonomy as it currently exists. However, investors might expect considerably more than this when backing a green fund. “Much more than this cannot be met by any product available in the market,” said Dogniez. Careful explanation by asset managers will be required.
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