As of 31 December 2022, the assets under management of funds classified as Article 8 or Article 9 amounted to 4,600 billion euros and represented 55% of regulated funds in Europe. European management companies, anxious to offer products labelled “green” to clients attracted by sustainable finance, sometimes have classified their funds wrongly as "article 9" and are now obliged to go back and reclassify their funds as "article 8" funds.
Blackrock, Amundi, Invesco, Pimco, DWS, AXA IM, Robeco, Deka, Neuberger Berman and others have downgraded tens of billions of euros of Article 9 funds, i.e. the funds considered most sustainable.
Sustainable finance, as defined in section 2 (17) of the “Sustainable Finance Disclosure Regulation” (SFDR), considers an investment to be sustainable if it has an economic activity that contributes to an environmental or social objective. This is also the case if the investment promotes human capital or economically or socially disadvantaged communities. It must not cause significant harm to any of these objectives and must be applied according to good governance practices. For example, the PAI (Principle Adverse Impact) indicators are used to demonstrate the absence of significant harm and include a minimum of 16 indicators of which at least 9 are environmental and 5 are social.
Impact funds are investment funds that focus on social and environmental causes. The SFDR regulation provides a framework for sustainable finance and impact funds in Europe. It is relatively recent as it only came into force in March 2021 and includes the famous articles 8 and 9 which rule on the disclosure of information relating to sustainable finance. Asset managers must therefore disclose a number of environmental, social and governance (ESG) parameters. They must also publish the characteristics and sustainability objectives of their funds (see Fig. 2).
Article 8, or "light green" funds, use sustainability criteria in their investment process. They use environmental, social and governance (ESG) criteria to screen out or select investments, alongside their existing financial and market analysis.
Article 9 or "dark green" funds have a sustainability objective for their investments, in addition to integrating ESG criteria, and really look at their impact. These funds therefore aim to have a real positive impact on the environment (see Fig. 3).
Since the regulation is recent, it does not seem to have been understood in the same way by the different management companies. Article 8 funds include the notion of a "constraint" in the investment selection process. Often, this constraint consists of the exclusion of certain sectors, for example companies in the mining sector or companies involved in the exploration and production of fossil fuels. But not all Article 8 funds are exclusionary. Others apply sustainable themes such as gender diversity, climate change, biodiversity loss, or water management.
Finally, the double materiality (cf. Fig.4) is part of the CSRD "Corporate Sustainability Reporting Directive", which regulates the extra-financial reporting of companies, but it is also part of the SFDR regulation, which requires transparency from companies towards investors.
The entry into force of the SFDR Level 2 regulatory technical standards (RTS) on January 1st, 2023, has prompted fund managers to scale back their ambitions. The new standards require managers to disclose more information on ESG approaches, sustainability risks of their funds, and their impact, in pre-contractual documents and periodic reports. A large majority of funds, 307 in total, have moved from an Article 9 classification, the most ambitious in terms of sustainability, to an Article 8 classification, representing €175 billion of assets (or 40% of Article 9 funds).
In the fourth quarter of 2022, Article 8 funds returned to positive net inflows of 10.7 bn euros. Article 9 funds, on the other hand, recorded their lowest ever inflows of 5.1 bn euros of fresh capital. But this low inflow is partly explained by the wave of funds that reclassified from Article 9 to Article 8 in the last three months of 2022 (see Fig. 5).
Regulators are currently developing mandatory product labels, which will come in addition to the SFDR disclosure requirements and will impact the use of existing classifications.
However, it is likely that companies and funds will have to comply with an increasing number of product classification requirements over the next few years until a European eco-label comes into force.
There are already a few "green" labels in Europe, including the "Nordic Swan" (based in Sweden and created in 1989 but first applied to an investment fund in 2017!), the "Luxflag" (created in 2011 in Luxembourg) or the "doctrine" (introduced by the AMF, in France, in March 2020).
For example, for a fund to be labelled "LuxFlag", it must:
In France, the "Doctrine" requires consistency between what is said in the marketing material and what is done in terms of ESG portfolio management. The AMF has stated that it considers the "Doctrine" to be complementary to the SFDR, but that it will reassess it in the light of the final SFDR level 2 rules and when the European Ecolabel is introduced.
As further clarifications are made by the SFDR and ESG measurement regulations continue to evolve, every asset manager must take steps to adapt to these changes. Managers and investment decision-makers who fail to incorporate these new rules into their business plans risk failing to meet European - or even global - standards. Investors are increasingly concerned about the impact of their investments, and regulation tends to provide them with all the information they need to make the right choices. ESG management is a constantly evolving subject, and management bodies are trying to respond to requests for clarification in order to avoid "green washing". The movement towards impact funds seems to be well under way. All that remains is to move towards greater transparency to allow differentiation between sustainability strategies and their real impact.