Fund Bosses Vent ‘Mass Frustration’ as ESG Tumult Grips Industry

(Bloomberg) — After a turbulent few weeks during which some of the world’s biggest asset managers removed coveted ESG tags from huge chunks of their business, industry bosses have had enough.

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Managers running the funds affected are now talking openly of the “chaos” they say has hit the investment management industry. Their main cause is a regulatory framework, whose confused rollout just blew a $125 Billion hole through top ESG market.

Matt Christensen, Allianz Global Investor’s head of sustainable and impact investing, said figuring out how to interpret EU ESG regulations is “taking over a lot of the life of my team and they’re very frustrated.” Axa Investment Manager’s head of sustainability coordination and governance, Clémence Humeau, warns of the fallout for clients as the wider ESG fund market becomes harder to navigate.

BlackRock Inc. and Amundi SA are just a few of the companies that have been drawn into the current frenzy of reclassifications. Funds they’d registered under the European Union’s highest environmental, social and governance designation — Article 9 — have now been bumped down to a lesser category — Article 8. Even those who track Paris-aligned climate benchmarks created by the EU weren’t green enough to retain the classification.

Many downgraded funds were found to have sustainability thresholds as high as 80%. Some even claimed to have 90% of sustainable investments. But since the EU’s Sustainable Finance Disclosure Regulation was enforced last year, the EU Commission has clarified its guidance around Article 9, so that only funds containing 100% sustainable assets, save for hedging and liquidity, can use the designation.

Jean-Jacques Barbéris, head of institutional and corporate client division and ESG at Amundi, said “highly unstable and highly incomparable” regulations mean the firm was “not comfortable with taking commitments” on Article 9. The fund industry is “under heavy scrutiny, under more demands from regulators, and adding an element of uncertainty” via regulations “adds a challenge to the sustainable investment journey,” he said.

The upshot is that the industry now finds itself in the grip of a kind of “mass frustration,” according to Luke Sussams, an ESG strategist at Jefferies International Ltd. The “complexity and scale” of the demands contained in SFDR have created a “huge opportunity cost” for the fund industry, he said, citing conversations with financial professionals affected by the regulation.

Germany’s financial regulator, BaFin, has signaled it welcomes the wave of reclassifications. The Article 9 downgrades are “a positive sign that the industry has recognized the greenwashing risk and takes it more seriously,” said Mark Branson, the head of BaFin. “There was a widespread trend to describe things as greener than they were and to see it as a part of marketing without linking it to the plausibility of investment processes.”

But other regulators say Europe’s ESG investing rules need some adjustments. Verena Ross, who chairs the European Securities and Markets Authority, has publicly urged EU officials to address the “real challenge” posed by the bloc’s evolving ESG rules. Among concerns voiced by ESMA is the lack of clarity around basic ESG concepts such as a “sustainable investment.” ESMA and other EU regulators have asked the EU Commission to provide answers.

Mairead McGuinness, the EU’s financial markets and services commissioner, said earlier this month that some asset managers appear to have taken too “liberal” an approach when assigning ESG designations to financial products. However, she promised a consultation regarding SFDR beginning in next year.

“We may need to take a much broader look at this regulation,” she told lawmakers on Dec. 6. McGuinness stated that if attempts to fix SFDR’s shortcomings fail, the EU might need to rewrite the regulation.

Asset managers claim that national regulators in the EU have been misinterpreting SFDR.

There’s an element of the “EU versus nation states,” Allianz’s Christensen said. “The mix is contributing to the chaos” because “you have so many different regulators still jumping in with interpretations.”

That wave of fund downgrades from Article 9 also raises questions around how to treat the much larger — and growing — fund class of Article 8, Axa’s Humeau said.

“As funds were reclassified from Article 9 to Article 8, there are now very different funds categorized as Article 8 in the market, with very different objectives and different levels of materiality of the ESG approach,” Humeau said. That will make it harder for clients to know what they’re getting in an Article 8 product, she added.

It is still up for debate whether Article 8 funds which have a total of $4 trillion in assets can claim to be ESG. EU requirements for the fund class to date have been vague, requiring only that it “promote” sustainability. Morningstar’s third quarter analysis found that over a third of Article 8 funds are not exposed to sustainable investments. Only 6% of Article 8 funds target sustainable allocations greater than 50%.

Last month, ESMA proposed setting minimum thresholds for funds marketing themselves as “ESG” or “sustainable.” A fund calling itself ESG should be required to be at least 80% ESG, while a fund calling itself sustainable should have no less than 40% sustainable assets, ESMA said. Morningstar estimates that only 18% of Article 8 funds meet this sustainability threshold.

For now, the safest bet seems to be to “go very conservative” on SFDR fund classifications, Christensen said. But when the dust settles on Europe’s ESG investing rules, and “we better understand the regulatory terrain,” some of the recent downgrades may well be reversed, he said.

Frances Schwartzkopff provides assistance.

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