Shades of green: Classifying ESG funds | Insights | Bloomberg Professional Services

This article was written by Nadia Humphreys and Murat Bozdemir at Bloomberg. 

Since the Sustainable Finance Disclosure Regulation (SFDR) came into effect in March 2021, there’s been a steadily increasing number of funds dubbed sustainable in the EU. However, just how sustainable these funds truly are, has been a recurring question. In the past few months, more than $125 billion of assets were reclassified from SFDR Article 9, funds with a sustainable objective, to Article 8, funds defined as promoting sustainability—a less stringent threshold. As of today, there are nearly 987 Article 9 funds compared to approximately 8,461 Article 8 funds, according to prospectus disclosures collected by Bloomberg.  This is a startling gap at face value, but it becomes less surprising when accounting for the drivers behind this migration.

New guidance impacts fund classifications

The definition of a sustainable investment under SFDR has been less than concrete. Regulators have provided somewhat limited implementation guidance, and as a result varying interpretations have flourished. Investment firms have turned to myriad of approaches to demonstrate their sustainable investment criteria, such as economic activity classification, ESG scores, use of proceeds from green or social bonds, carbon reduction goals, EU Taxonomy alignment, just to name a few.

Compounding these challenges, European supervisors have provided new guidance specifying the required percentage of sustainable investments in Article 9 funds. Pre-contractual information from sustainable fund managers provided to Bloomberg indicate that only a small portion of Article 9 funds are aiming for more than the minimum of 80% sustainable investments. However, according to recent guidance from the European Commission[1], Article 9 funds should now aim for 100% of fund assets to be invested in sustainable investments. This change adds a bit more color as to why over $125 billion assets have shifted from Article 9 to Article 8 funds.

At the same time, classifying a fund as Article 8 or 9 has become a popular proxy for an ESG label. This is risky given the lack of clear guidance on what constitutes as a sustainable investment, especially now that Article 9 funds must be 100% invested in something ‘sustainable’. To navigate this ambiguity, firms need to find defensible ways to assess the investment strategy of ESG funds.

Assessing ESG funds

The starting point for a better understanding of a fund’s sustainability credentials is to review new mandatory disclosures linked to a fund’s target minimum EU Taxonomy alignment, screening criteria, benchmarks, and which Principle Adverse Impact (PAI) indicators are considered during the investment process. By taking into account these factors investors can have a more complete view of how ESG goals are achieved. However, finding all of these datapoints can be a challenge. To streamline the process and provide reliable information, Bloomberg is releasing over 160 new ESG fund reported data points in Q1 2023.

Additionally, Bloomberg’s Fund ESG Analytics solution provides objective and standardized ESG data for mutual funds and ETFs, enabling clients to easily compare funds independently, and invest according to their own ESG objectives and preferences even if funds have no disclosures. It leverages Bloomberg’s vast database of fund holdings and our award-winning ESG data.

Exposure to negative environmental & social factors

One of the key innovations of SFDR is the introduction of standardized indicators that measure how exposed investments are to environmental and social factors that have a potential negative impact on sustainability, the Principle Adverse Impact (PAI) factors. Some of the key PAI considered by ESG funds in the investment strategy are social metrics such as UNGC violations and controversial weapons, as well as environmental metrics focused on the carbon footprint of investments.

The industry is still grappling with the level of available company data linked to the PAI. For example, reported company data around activities negatively affecting biodiversity, water emissions and gender pay gap is still very scarce.

The SFDR PAI are not sector specific and no materiality thresholds have been provided by the regulator. As a result, it’s difficult to assess if available data is representative for a portfolio of companies. Better and more company data will be reported once the  Corporate Sustainability Reporting Directive (CSRD) goes live in 2025, so it will take a few more years before reported data will bridge some of the data gaps the industry has to deal with today. Besides reported data, high quality estimates for key environmental metrics such as carbon and biodiversity are needed to support a data-driven sustainable investment strategy.

Bloomberg’s SFDR solution helps investors with the challenging disclosure of PAI indicators by mapping them to company reported ESG data on over 15,000 companies globally, covering 88% of global market cap. The solution can also be used by fund managers to track and pick investments that align with the PAI. To help investors understand the carbon footprint of portfolio investments, Bloomberg provides company reported emissions and estimates for Scope 1, 2 and 3 emissions resulting in coverage of over 130,000 companies.