The turmoil continues. In mid-April, European authorities published a series of clarifications and proposals that have much of the region’s investment management industry heading back to the drawing board. Some asset managers even question whether they were wrong to downgrade their Article 9 funds in the first place.
Crucially, the EU failed from the get-go to provide a clear definition of a sustainable investment, which allowed fund managers to come up with wildly different definitions when designing portfolios. The European Commission, the EU’s executive arm and a principal architect of SFDR, has now attempted to clarify how it wants investors to treat the concept of “sustainable investment.” The upshot appears to be that asset managers will have considerable leeway, and the onus will be on investors to figure out what they’re getting with this guideline: If a company gets only a portion of its revenue from a sustainable activity, but otherwise doesn’t do any significant environmental or social harm, investors can consider that an overall sustainable investment.
“I think someone on the Commission side has gotten worried that the whole edifice of SFDR might not get the respect that it deserves,” says Eric Pedersen, head of responsible investments at Nordea Asset Management. “And so they’re trying to fix some of those things.”
The list of things to fix remains long. Article 9 is supposed to be reserved for funds that put all their money into sustainable investments, yet Morningstar said in late January that only about 6% of them are anywhere close to meeting that standard.
A November study by Clarity AI, a sustainability technology platform, found that almost 1 in 5 Article 9 funds have more than 10% of their investments in companies that violate the United Nations Global Compact principles or the Organization for Economic Cooperation and Development’s guidelines on the environment and human rights. Another problem is that numerous funds were downgraded to Article 8’s vague “must promote ESG” classification. Regulators are trying to figure out how to come up with a more meaningful framework.
Late last year, the European Securities and Markets Authority, the region’s top markets regulator, added to the chaos. It said the EU should apply minimum thresholds to any funds that market themselves as ESG or sustainable. At least 80% of a fund sold under an ESG label must be verifiably ESG. If it also calls itself sustainable, at least half of the 80% must be verifiably sustainable. The idea has elicited almost universal condemnation from market participants.
The regulator is plowing through the feedback but has said it still aims to move ahead with some version of its proposal this year. If the plan ends up being enforced in its current form, Morningstar figures that only 27% of the more than €4 trillion in fund assets it estimates are registered as Article 8 could be marketed as sustainable.
None of this means ESG is doomed to fail. Pedersen at Nordea says it’s wrong to expect anything other than a drawn-out process when reimagining the laws of capital allocation. Attention to detail—in other words, data and transparency—will ultimately make the difference in whether investors understand what an ESG label really means. The US should take note.
Bloomberg
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