scorecardresearchFunds Hit Brakes as Reclassifications Take Toll: ESG Regulations

Funds Hit Brakes as Reclassifications Take Toll: ESG Regulations

Updated: 06 Jan 2023, 08:11 AM IST
TL;DR.
Asset managers grappling with continuous ESG regulatory updates in the European Union may soon opt to fight back, rather than try to adapt to a moving target.
FILE PHOTO: A U.S. dollar banknote is seen in this illustration taken July 17, 2022. REUTERS/Dado Ruvic/Illustration/File Photo

FILE PHOTO: A U.S. dollar banknote is seen in this illustration taken July 17, 2022. REUTERS/Dado Ruvic/Illustration/File Photo

(Bloomberg) -- Asset managers grappling with continuous ESG regulatory updates in the European Union may soon opt to fight back, rather than try to adapt to a moving target.

Seen as the world’s most ambitious green investing rulebook when it was enforced in March 2021, the Sustainable Finance Disclosure Regulation has since faced growing criticism. An SFDR update just triggered a huge wave of fund reclassifications, which investment firms, lawyers and even some regulators blame on confusing rules. And there’s more in the pipeline.

One proposed update now has the industry particularly worried. A little over a month ago, portfolio managers woke up to a plan by the European Securities and Markets Authority to force funds to meet minimum thresholds if they use ESG- or sustainability-related words in their names. An ESG fund would have to show that at least 80% of its investments contribute to its claims under the latest proposal. Sustainable funds would have to meet that same 80% threshold, and prove that half those assets also live up to SFDR’s three criteria for a sustainable investment.

Anna Maleva-Otto, a partner at Schulte, Roth & Zabel LLP, said the criteria demand not only that an investee company pursue a sustainable goal, but also that it do no significant harm in other areas. Proof is hard to come by, because firms aren’t yet required by regulators to provide adequate documentation.

“The more you start getting technical and the more you start tying people into specific quantitative thresholds, the harder it will be in practice for anyone to comply,” Maleva-Otto said. 

For fund managers unable to meet ESMA’s thresholds, the choices are stark, she said. “It’s one thing with a new fund, but it’s another thing with a fund that already exists and has a name and has been marketed.” 

To change a fund’s name “isn’t going to be practicable,” she said. Instead, “I think the industry is going to fight it.”

ESMA’s proposal, which has been put to a consultation that runs until Feb. 20, has the potential to upend the entire market for so-called Article 8 funds, the EU’s broadest ESG designation which has so far been slapped on roughly $4 trillion worth of assets. That follows stricter guidelines around the EU’s top ESG category, known as Article 9, which have already resulted in funds worth well over $125 billion being downgraded.

Fund managers “are having to make subjective decisions because there is no data available” on the sustainability metrics they need to document, Maleva-Otto said. And for assets like “infrastructure projects, real estate, any kind of credit investments, the analysis gets harder and harder, because there just isn’t this data available.”

 

First Published: 06 Jan 2023, 08:11 AM IST