European asset managers need guidance on which fund names should be interpreted as suggesting a focus on sustainability considerations if they are to avoid greenwashing allegations.
Late in 2022, numerous funds in Europe set up under the coveted Article 9 – funds that explicitly focus on sustainable investments, as per the EU’s Sustainable Finance Disclosure Regulation – were suddenly “downgraded” to Article 8 status, in what many commentators consider to be a blow to sustainable investing.
This rapid shift came just as the SFDR’s regulatory technical standards (RTS) were set to come into force in January 2023, and it reflects the high degree of anxiety and confusion among asset managers when it comes to avoiding potential greenwashing allegations and ensuring that their financial products comply with all relevant regulations.
Regulatory authorities, at both the EU and member state levels, are acutely aware of this confusion brewing within Europe’s asset and wealth management industry, and the European Securities and Markets Authority published a consultation paper back in November proposing much-needed guidelines on naming funds with environmental, social and governance or other sustainability-related terms.
Virtually all industry stakeholders agree that there is a lack of clarity on what exactly constitutes a fund name with ESG or sustainability-related terms, and this is causing much consternation. For instance, a hypothetical fund called “Blue Fund” might be committed to ESG or sustainable investments, even though its name does not explicitly refer to either ESG or sustainability.
This is but one example of the kind of confusion that has been arising in Europe’s asset and wealth management industry since the SFDR was introduced in late 2019. Esma’s guidelines, expected to be finalised later in 2023, come at the right time – but there are several points that need further elucidation and discussions if we are to adequately tackle such confusion and meaningfully pave the way for sustainable investing in Europe.
Strict thresholds
When it comes to the design of their financial products, even the most ambitious ESG-minded asset managers seeking to sell sustainable products need to put in place realistic objectives tied to measurable ESG targets. Regarding the E component, investments that focus on the climate are the most common, as this is the area where science-based methodologies to gather data on greenhouse gas emissions have been developed and perfected across the years.
Therefore, it is not surprising that asset managers focusing on the environment will prioritise climate change-related investments and focus less on other areas such as biodiversity preservation or pollution reduction as there is not enough data or internationally accepted, science-backed methodologies in those areas.
The Taskforce on Nature-related Financial Disclosures, an international initiative seeking to develop disclosure standards and frameworks on nature-related risks, was only launched in June 2021 – while the GHG Protocol, a landmark tool used by corporations to measure their greenhouse gas emissions, has been in existence since the early 2000s.
This is where the Esma-proposed guidelines become problematic, as funds with any ESG-related terms in their name will need to have at least 80 per cent of their investments focused on meeting these characteristics in accordance with the fund’s investment objectives.
Such a quantitative threshold can be problematic since, apart from the fact that the proposed guidelines offer no justification for their inclusion, they may push asset managers to focus only on investments in areas where data is already readily available — such as large-cap companies that adequately disclose their greenhouse gas emissions — and eschew other areas in the world of sustainability.
As long as comparable information is not available, and as long as it is difficult to create financial products on biodiversity and pollution – due to the lack of data, regulations and methodologies – asset managers will probably avoid these areas that are crucial in the fight against climate change, and instead continue focusing on emissions-related indicators and metrics. Esma’s proposed guidelines and its somewhat arbitrary thresholds might only worsen this trend.
Status changes
Although it is possible that many asset managers will seek to reinsert many of their “downgraded” funds to Article 9 status, it is likely that this will not happen soon, even after Esma’s proposed guidelines become finalised and stakeholders have more clarity regarding fund names.
After all, the wave of downgrades was largely done to reduce regulatory and greenwashing risks for investors, and, as they currently stand, the regulations and consultations that have been taking place with industry stakeholders have not yet managed to dissipate these risks.
In addition, when asset managers changed the status of their Article 8 and Article 9 funds, they had to provide their national regulatory agencies with an explanation over such decisions, particularly regarding why they reduced the sustainable ambitions of their products. Thus, it would not be a very savvy move on the reputational side for asset managers to seek to reapply for Article 9 status so soon after they changed their funds’ SFDR status.
In all cases, Esma’s proposed guidelines focus on problems in the distribution and marketing sides of financial products, but do not necessarily help in the products’ design. The SFDR itself is not a labelling regime after all, but a reporting and disclosure regulation. We are likely going to see third-party labels – such as those developed by the Luxembourg Finance Labelling Agency – organised to complement it.
Such a development, alongside more regulatory clarity on funds’ names, would be much-welcomed. Investors would thus be able to better identify products that engage in sustainable investments, while asset managers would be able to have a trustworthy certificate demonstrating their sustainability ambitions, commitments and objectives.
Ultimately, Esma’s proposed guidelines – despite the existing flaws – are an important addition to the overall sustainable finance landscape in Europe. The challenge will be for regulators and asset managers to ensure complementarity and interoperability between regulatory frameworks, guidelines and labelling regimes, so that the sustainable finance landscape in Europe can continue to grow and play a leading role in the fight against climate change.
Frédéric Vonner is advisory partner at PwC Luxembourg