Some long awaited regulatory clarity on ESG and sustainability requirements for fund and asset managers appears to have reduced the state of confusion that had led to a downgrade of approximately 270 billion euro in assets under management last year. Yet, some specialists believe that claims of greenwashing that have plagued the industry in the last year are at serious risk of continuing.
Some people familiar with European ESG regulation in Luxembourg, Brussels and elsewhere in Europe, said the market appears to have switched towards a mode of acceptance after the European Commission clarified the EU’s Sustainable Finance Disclosure Regulation first introduced in 2021. One even anticipates a possible roll-back of the hundreds of SFDR reclassifications of investment funds, although this would not be soon.
“Things are clearly getting better,” a London-based ESG specialist with a global private bank headquartered in the EU who asked not to be named told Investment Officer. “It’s getting much clearer. A year from now we will be in a better place. We might even see a roll-back of SFDR classifications.”
Not everyone is as enthusiastic. “The pace of legislation and regulation in Europe is so fast and it is constantly changing. What is the right thing now is not tomorrow. It gives investors discomfort and uncertainty,” Eugenia Unanyants-Jackson, global head of ESG at PGIM, told a recent AFME conference in Amsterdam.
In Luxembourg, industry participants see the developing sustainability legislation as an opportunity, but clearly one that needs time and that needs credibility. The EU’s upcoming comprehensive SFDR review this summer is regarded as a key moment to make these adjustments.
‘Fear of non-compliance’
“The ESG regulation is massive and financial institutions need sufficient time to integrate ESG considerations into strategic planning, products and services offering, operational processes and reporting mechanisms,” said Julien Froumouth, adviser sustainable finance at bank association ABBL.
“The fear of regulatory non-compliance, and the need for specialist knowledge and understanding required, is driving many to seek external support,” said Gaëtan Parchliniak, head of regulatory affairs at FundRock, a third-party management company in Luxembourg.
When it comes to SFDR, the EU last month made clear the regulation is disclosure-based, telling investors that they are responsible for demonstrating how their approach to sustainable investment complies with requirements. It also made clear that assets covered by transition plans, as is the case for some oil company investments, would not automatically be considered ‘sustainable’.
The European Commission provided its guidance on 14 April after EU financial supervisors last September warned that the fund and asset management industry needed better guidance on how to classify funds under the SFDR. The regulation basically created three types of funds. ‘Article 6’ for non-sustainable investments, also known as ‘black’ or ‘brown’ investments; ‘Article 8’ for funds with some sustainability or ESG objectives, aka ‘light green’ funds; or ‘Article 9’ for those with clear sustainability objectives, aka ‘dark green’ investments.
The unofficial colour-coding is widely applied in an attempt to make clear the differences between the kind of funds. It is a relatively simplistic way to explain the differences. Experts in charge at funds prefer to speak about more complex investment objectives, such as “being aligned” with the Paris climate agreement or with specific benchmarks set for the climate transition, as “net zero”, or as “Do No Significant Harm” and as “good governance”.
De facto used as labels
Although the SFDR classifications were never designed as labels, the growing popularity of sustainable financial products among investors, especially in Europe, led fund product developers to use classifications also for marketing of the funds, de facto using them as labels.
Greenwashing fears then swiped the industry last summer after German police raided the Frankfurt offices of DWS and Deutsche Bank. They suspected that the fund manager had systematically exaggerated the sustainable nature of its products. The head of DSW subsequently stepped down. A growing recognition among the general public, also inspired by media reporting, made the industry even more reluctant to promote Article 9 funds. What ensued was a mass exodus from Article 9 during the months that followed. Many funds were downgraded to Article 8 or Article 6. It led to a significant reallocation of assets between funds.
Research agency Matter, in a 1 May report, estimated that some 270 billion euro in assets was downgraded between September and January, mostly in passive strategies using Paris-aligned or climate transition benchmarks. Matter said the European Commission’s recent guidance has provided “important clarity” for fund providers.
Still vulnerable to greenwashing
In a 55-page analysis, Matter said the fresh EU guidance makes clear the classification will be, within reason, at the discretion of the fund providers, which, in its view, is not without risks. Specifically, it leaves the industry still vulnerable to greenwashing claims.
“This risks (are) moving too far in the other direction. A middle ground is necessary in order to strike a balance between usability and usefulness and prioritising usability of the Article 9 classification, whilst sacrificing clarity between different fund types,” said Matter.
“Similarly, opening definitions up to the discretion of fund providers means that claims of greenwashing that have plagued SFDR today are at serious risk of continuing.”
At ABBL, Froumouth made clear that greenwashing needs to be prevented if the regulation is to remain credible. “Fighting greenwashing is absolutely key to achieve sustainability objectives, and that requires efforts from all stakeholders, from policy makers, companies, financial institutions themselves to actors of the civil society,” he said.
Brussels-based fund managers association Efama pointed out that the industry has adopted a very cautious approach. “Yes, fears of greenwashing are definitely a factor for managers of ESG funds, and many are taking a very conservative approach. It’s crucial to ensure that their investment strategies are transparent, accurate, and aligned with the values of their investors,” Efama told Investment Officer..
Legal and reputational risks remain
In a commentary note to members, the London-based Institutional Investors Group on Climate Change, or IIGCC, drew attention to the need for investment managers to exercise caution to avoid accusations of greenwashing.
“The continued lack of prescription means there remains a risk that investors will continue to take a broad range of approaches to measure the sustainability of their investments,” IIGCC said. “Not only could this reduce the ability to meaningfully compare funds, but it may continue to expose investors to legal and reputational risk when it comes to the sustainability-related claims they make as part of their SFDR reporting.”
The European Commission this summer is expected to embark on a wider review of the sustainable finance regulation. SFDR interacts with a range of EU regulatory initiatives that also encompasses the EU taxonomy and the CSRD, the directive on corporate sustainability reporting. The non-financial data that companies will report on from the coming years also will give fund managers more insights into the sustainability aspects of their investments.
“The ongoing broad review of SFDR by the European Commission is a crucial opportunity to pursue a middle ground approach which strikes a balance between usability for fund managers and usefulness for investors looking to invest sustainably,” said Matter’s ‘Dividing Lines’ report.
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