• Numerous funds reclassified according to various sustainability criteria
• Classification according to Article 6, 8 or 9 opens the door to regulatory checks
In 2019, the European Commission launched the Green Deal to lead the European Union to climate neutrality by 2050 and to promote sustainable management. The deal includes extensive measures for a wide variety of economic sectors. An important aspect here is the concept of “sustainable finance”, i.e. a sustainable financial sector. In concrete terms, this means that sustainability criteria should be taken into account in the decision-making processes for investments and financing. Various ESG criteria have been defined for this.
Classification in different ESG classes
Banks, asset managers, insurance companies and institutional investors play an important role in supporting the EU on its way towards more sustainability. For this reason, a specially tailored regulation, the Sustainable Finance Disclosure Regulation SFDR, was established for financial companies. According to this regulation, the financial institutions must disclose to what extent sustainability criteria have been incorporated into their decisions and what sustainability effects their financial products have. ESG financial products can be placed according to various criteria, which in turn are linked to various transparency obligations. ESG products according to Article 6 represent the lowest requirements. Here it only needs to be disclosed whether and to what extent sustainability criteria were taken into account in the investment. If this was not the case, this must also be communicated and justified.
Article 8 ESG financial products are also referred to as “light green” funds. This type of fund pursues a dedicated ESG strategy and also promotes it, which must be communicated transparently and also mentioned in the annual financial statements. However, Article 9 funds offer the highest ESG standard. They fall into the “dark green” or “dark green” category. These financial products not only follow a specific ESG strategy, but also commit to a declared investment goal. This also goes hand in hand with an extensive duty of transparency. The different fund categories were created to make it easier for investors to make informed investment decisions.
Numerous funds reclassified
Since the launch of the Green Deal and the various ESG standards, numerous funds have therefore been reclassified as they correspond to the various articles. As Bloomberg reports, the Article 8 category is particularly popular. Since its introduction in March last year, around 700 funds in the EU have now been assigned to this ESG class. According to Morningstar data, these funds are worth around US$3.8 trillion, which is half of all EU-domiciled funds.
However, as already described, the classification according to Article 8 is accompanied by a number of disclosure and transparency obligations, which opens the door for reviews by regulators and investors. The lawyers for the asset managers who carried out the reclassification of the funds recently warned of this, reports Bloomberg. This means that even funds that have been in existence for a long time and have now been reclassified cannot avoid being checked.
As Ciara O’Leary from the law firm Dechert LLP explains to the news portal, the classification by the assets managers was carried out in particular “under pressure from the operating channels”. The ESG rules in particular, which have been continuously adapted in the year and a half since their introduction, pose major challenges for the financial sector.
According to Morningstar, well over 600 funds were upgraded from Article 6 funds to Article 8 funds in the second quarter of 2022. Only 16 were downgraded from Article 9 to Article 8. However, the data analysis firm has already found that 23 percent of Article 8 funds also included arms manufacturers, oil giants and tobacco companies, making them not actually ESG-compliant.
Wealth manager in a bind
In addition, fund managers say they are being pushed by their distributors to offer more Article 9 funds. According to Morningstar, six billion US dollars flowed into such funds in the last quarter. Article 8 funds, on the other hand, would have seen an outflow of $30 billion over the same period. The higher classification not only increases the risk of being downgraded again, but also the likelihood of being sued “by an investor, an NGO, a state regulator” because the criteria were not precisely met, Bloomberg quotes the lawyer Ken as saying Rivlin. “It’s more important than ever that the facts match the statements of what a fund is doing. And that’s a real shift for these funds because the demand is so great.” According to O’Leary, the risk of a downgrade should not be reduced either. Such a possibility should be considered in relation to misrepresentation or sale by making false claims.
However, many asset managers are also reclassifying funds because they now have more guidance from regulators. But there are also new rules. For example, an EU directive was recently amended in such a way that financial advisors now have to query the ESG preferences of investors and then also have to fulfill them.
O’Leary says many wealth managers are “a bit nervous because they’re breaking new ground” because of all these innovations. The fund providers don’t want to undersell or downgrade themselves if they don’t absolutely have to, but they are also “somewhat caught between the stools.”
Editorial office finanzen.net
Image sources: wk1003mike / Shutterstock.com, Miha Creative / Shutterstock.com