The Downgrading Trend

Why many asset managers are implementing a more cautious approach to ESG classification 

From January 2023 onwards, the second level of SFDR regulation will come into force, entailing new obligations on financial services providers and the introduction of RTS (Regulatory Technical Standard). Despite the SFDR’s honourable goal, its classification is creating a lot of confusion in the market and is forcing many asset managers to downgrade their sustainable investments.

The Sustainable Finance Disclosure Regulation (SFDR), originally introduced in March 2021, aims at increasing transparency in ESG investing and at preventing greenwashing through the imposition of new disclosure obligations on financial companies. Hence, under the latest SFDR rules, asset managers must classify their funds under one of these three categories, depending on their sustainability objectives: Article 9 (also known as “dark green” products, the ones pursuing specific environmental or social strategies), Article 8 (also known as “light green” products, the ones promoting environmental or social characteristics) or Article 6 (also known as “grey” products, the other ones, which do not consider sustainability as a key investing factor). In addition, July’s guidance clarifies that Article 9 funds must invest in firms already labelled as sustainable, eliminating all so-called transition investments, which are financing companies that have set sustainability goals but have not achieved them yet. 

The products classified as “green” are then subject to additional disclosure requirements, mainly related to how the sustainable objectives are met. 

This classification, though theoretically useful to compare investments’ sustainability profiles and to help investors better understand the impact of their investment decisions, is actually significantly complex in practice. First of all, some important information is not yet published by the firms financial companies invest in, making classification and disclosure obligations nearly impossible. In addition, the classification applies more stringent eligibility criteria compared to other ESG categorizations, and this is the main issue asset managers have to deal with.  

Indeed, in order to align their ESG classification to these stricter rules, many asset managers are downgrading their ESG funds, shifting them from the Article 9 category to the broader, and less demanding, Article 8 one. According to Morningstar research, among these financial services providers, we can find Amundi, BlackRock, Axa, Invesco, NN Investment Partners, Pimco, Neuberger Berman, Robeco, Deka and many others.  

This more cautious approach, according to the asset managers themselves, doesn’t constitute an actual acknowledgement that the funds in question are now less sustainable, but on the other hand, arises from the concern of protecting themselves in front of the evolving regulation. However, since the SFDR classification has been widely used as a taxonomy, asset managers are worried that these downgrades will upset their clients, which have allocated money to Europe’s top ESG category and then discovered the classification has changed, even if the ESG risk has not.  

This is why many asset managers and financial associations, such as Eurosif, are asking for further innovation in SFDR rules, able to align them to reality and to the market.  

In conclusion, it is important to understand that this trend is due to the approaching start date of the new regulation and to the fear that misleading ESG information will be severely punished by the new stricter regulation.  

Sources: 

Author: Edith Oldani

The Downgrading Trend

Why many asset managers are implementing a more cautious approach to ESG classification 

From January 2023 onwards, the second level of SFDR regulation will come into force, entailing new obligations on financial services providers and the introduction of RTS (Regulatory Technical Standard). Despite the SFDR’s honourable goal, its classification is creating a lot of confusion in the market and is forcing many asset managers to downgrade their sustainable investments.

The Sustainable Finance Disclosure Regulation (SFDR), originally introduced in March 2021, aims at increasing transparency in ESG investing and at preventing greenwashing through the imposition of new disclosure obligations on financial companies. Hence, under the latest SFDR rules, asset managers must classify their funds under one of these three categories, depending on their sustainability objectives: Article 9 (also known as “dark green” products, the ones pursuing specific environmental or social strategies), Article 8 (also known as “light green” products, the ones promoting environmental or social characteristics) or Article 6 (also known as “grey” products, the other ones, which do not consider sustainability as a key investing factor). In addition, July’s guidance clarifies that Article 9 funds must invest in firms already labelled as sustainable, eliminating all so-called transition investments, which are financing companies that have set sustainability goals but have not achieved them yet. 

The products classified as “green” are then subject to additional disclosure requirements, mainly related to how the sustainable objectives are met. 

This classification, though theoretically useful to compare investments’ sustainability profiles and to help investors better understand the impact of their investment decisions, is actually significantly complex in practice. First of all, some important information is not yet published by the firms financial companies invest in, making classification and disclosure obligations nearly impossible. In addition, the classification applies more stringent eligibility criteria compared to other ESG categorizations, and this is the main issue asset managers have to deal with.  

Indeed, in order to align their ESG classification to these stricter rules, many asset managers are downgrading their ESG funds, shifting them from the Article 9 category to the broader, and less demanding, Article 8 one. According to Morningstar research, among these financial services providers, we can find Amundi, BlackRock, Axa, Invesco, NN Investment Partners, Pimco, Neuberger Berman, Robeco, Deka and many others.  

This more cautious approach, according to the asset managers themselves, doesn’t constitute an actual acknowledgement that the funds in question are now less sustainable, but on the other hand, arises from the concern of protecting themselves in front of the evolving regulation. However, since the SFDR classification has been widely used as a taxonomy, asset managers are worried that these downgrades will upset their clients, which have allocated money to Europe’s top ESG category and then discovered the classification has changed, even if the ESG risk has not.  

This is why many asset managers and financial associations, such as Eurosif, are asking for further innovation in SFDR rules, able to align them to reality and to the market.  

In conclusion, it is important to understand that this trend is due to the approaching start date of the new regulation and to the fear that misleading ESG information will be severely punished by the new stricter regulation.  

Sources: 

Author: Edith Oldani

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