Money managers have been hit by more bad news about top ESG funds

Europe’s leading ESG fund class could be on the verge of turning point.

Dubbed Article 9 today, hundreds of funds could be stripped of the designation in the coming months, industry estimates show. There are now signs that investment clients are beginning to pull back as new data points to a significant slowdown in inflows.

And on Thursday, a report indicated that some Article 9 funds hold assets that could violate UN and OECD standards, from bribery to environmental damage.

Many fund managers “are trying their best and have spent millions in legal fees to make sure they’re taking the right approach,” but “results won’t be consistent across the industry,” and that “creates systemic risk,” said Hugo Gallagher, senior policy adviser at the European Sustainable Investment Forum, whose members represent approximately US$20 trillion in assets under management.

It’s a development that exposes worrying gaps in an ESG regulatory framework that was once hailed as the world’s most ambitious.

Since the Sustainable Finance Disclosures Regulation came into force in March 2021, the EU has had to make some clarifications. This includes telling the industry that all Article 9 funds must be fully sustainable, with some allowances for hedging and liquidity.

A study by Clarity AI found that nearly 20 percent of the 750 Article 9 funds analyzed have more than 10 percent invested in companies “that violate the principles of the United Nations Global Compact or the OECD Guidelines for Multinational Enterprises.” . His research also shows that 40 percent of the funds studied are more than 5 percent exposed to such violations.

“Classification of funds under SFDR guidelines is increasingly being used by fund providers as a shorthand way to communicate that a product is sustainable,” Clarity AI said in the report, written by a team led by Patricia Pina, the head of the company, has been created product research and innovation.

“However, our analysis indicates that some of the Article 9 funds currently on the market may not meet the Do No Significant Harm criteria as defined in the regulation,” the authors wrote.

The report followed a Morningstar study that found last week that less than 5 percent of funds meet the EU’s requirements to hold only sustainable assets.

Morningstar also noted that some asset managers have a “surprisingly” lax approach to Article 9, with 43% of the funds analyzed targeting a sustainable asset threshold of less than 50%.

“Wealth managers looking to avoid greenwashing allegations appear to downgrade,” said Lara Cuvelier, an activist with environmental nonprofit Reclaim Finance.

“National regulators need to take on the issue and define red lines on what should not be included in a ‘sustainable’ fund. It needs minimum standards.”

Article 9 funds attracted significant client inflows in the first nine months of this year, while a less strict SFDR category known as Article 8 lost money.

In the third quarter, Article 9 products attracted nearly $13 billion compared to nearly $30 billion in Article 8 outflows, Morningstar estimates.

Investments in Article 9 funds slowed last month, with clients investing just $1 billion in the top SFDR category, according to analysis by Bloomberg. Right now, Article 9 “is still attracting money,” said Hortense Bioy, Morningstar’s global head of sustainability research.

But “some managers report reduced client appetite due to reclassification and greenwashing concerns.”

At the same time, the EU’s ESG framework has been criticized for creating confusion.

The requirement that Article 9 funds must be exclusively populated with sustainable assets, which was not clarified until long after the SFDR was enforced, means that many companies with between 80 percent and 90 percent sustainable assets may also be on the wrong side of the regulations stand.

That raises “questions about the feasibility of the new regulatory guidance,” Morningstar said.

Due to the uncertainty now surrounding SFDR, Goldman Sachs Group’s NN Investment Partners plans to downgrade 10 Article 9 funds this quarter, following similar steps taken in previous months.

Axa Investment Management plans to trim 24 Article 9 funds after downgrading 21 funds in recent months.

Robeco Institutional Asset Management has announced that it will take similar steps. Pacific Investment Management, Van Lanschot Kempen and Neuberger Berman Group are among the companies that have already removed the Article 9 label from several funds.

“We expect more reclassifications in the market,” said Malene Christensen, sustainable investing expert at Robeco.

Meanwhile, wealth managers are waiting for the EU Commission to explain what it means by “sustainable investing” alongside other fundamental ESG concepts.

The EU Commission said last month it had received such “requests” and would “response in due course”.

Confusion surrounding the naming of SFDR funds has prompted EU regulators to publicly criticize the bloc’s ESG investing framework.

Verena Ross, Chair of the European Securities and Markets Authority, last month called the existing framework a “real challenge” and noted that it was “extremely difficult” for market participants to navigate.

The UK’s Financial Conduct Authority has specifically said its ESG investing framework will avoid the same mistakes across fund categories.

Some lawyers are advising asset managers not to take any action until the EU closes the loopholes in SFDR.

Anna Maleva-Otto, a partner at Schulte, Roth & Zabel, which primarily represents alternative investment managers based in the UK and US, said: “Such a reclassification is likely to present a material issue from an investor relations perspective and such a decision would be required to be done very carefully.”

(©Bloomberg) Money managers have been hit by more bad news about top ESG funds

Fry Electronics Team

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