Asset managers must deal with hundreds of downgrades of ESG funds.
In the upcoming months, hundreds of ESG funds may need to be reclassified by ASSET managers throughout Europe.
Only a small portion of funds designated as Article 9 investments—the EU’s harshest ESG category—accord with the standard of sustainable investments needed by European regulations, according to reviews by academics like Morningstar.
Legal professionals who advise the sector are now cautioning that many fund managers may be forced to revise their formal ESG designations.
The end result is that customers who believed they had chosen the EU’s cleanest ESG product are now stuck with something else.
Rahul Manvatkar, an investment funds partner at Linklaters in London, predicted that many ESG designations would be reclassified from Article 9 to Article 8, which has fewer restrictions.
Even though they might not want to, it is likely to be the trajectory as market players become familiar with the rules.
Following EU guidance, a number of well-known asset managers have already used downgrades.
These include NN Investment Partners of the Goldman Sachs Group and Pacific Investment Management, which downgraded 10 funds and reclassified 4 funds from Article 9 to Article 8.
In March 2021, Europe put into effect the most comprehensive set of guidelines for environmental, social, and governance (ESG) investing. But it is only now that the full scope of the difficulties raised by that framework—the Sustainable Finance Disclosure Regulation—is becoming clear.
Fund managers claim they lack far too little data to comply, and SFDR is always being improved as rulemakers become aware of deficiencies.
An Article 9 fund “may invest in a wide range” of assets “if these underlying assets qualify as sustainable investments,” according to the EU Commission, while taking into account liquidity and hedging requirements.
In other words, according to Hugo Gallagher, senior policy adviser at the European Sustainable Investment Forum (Eurosif), whose members manage about US$20 trillion in assets, EU authorities have “made it clear that Article 9 funds should commit to invest almost exclusively in sustainable investments”.
According to data source FE fundinfo, more than 300 Article 9 funds have disclosed a minimal threshold in sustainable investments that is less than 90%, placing them at risk of losing their classification.
The fact that many more did not disclose their sustainability goals suggests that the number may actually be significantly greater than 300.
Regulators are finding it difficult to understand the rules. The three financial regulators in the EU have requested greater clarification from the European Commission on a number of key matters related to the definition of sustainable investments.
The European Securities and Markets Authority have stated that it will interfere if necessary, but in the meanwhile, national agencies are left to monitor the sector.
