The recent reclassification of many “light” green article 8 funds and “dark green” article 9 funds has much to do with evolving regulation and lack of clarity around sustainability criteria, said a Trackinsight note published in March 2023. The use of the word “sustainable,” or similar terms, poses challenges, found a report from sustainability technology platform Clarity AI published on 15 May.
“When looking at funds with all three investment fund regimes--the US’, UK’s and EU’s--we found that over 95% of funds with the word ‘sustainable,’ or similar term, would require renaming or restructuring in order to be sold across all three markets,” said Patricia Pina, head of product research and innovation at Clarity AI. “This is not only an added cost in terms of compliance, but also underscores how different actors--in this case regulators--are interpreting the meaning of core concepts like ESG and sustainability.”
Here are five takeaways from Clarity AI’s analysis.
Commonly used terms: ESG, climate and responsible
Clarity AI analysed data from 18,000 funds across Europe, focusing on funds with English-language names. The platform’s research suggests that “nearly 70% of funds in Europe have names in English,” noted the report.
ESG, climate and responsible were the most commonly used ESG-related words in EU funds.
Article 8 as “catch all category”
The report also examined funds that contained the term “sustainable,” as well as related derived terms, including: “sustainable”, “sust”, “sustainability”, “sus”, “sustnby”, “sustain”, “sstby” or “sstnb”.
Clarity AI found that 74% of article 8 funds--which are funds that promote environmental and/or social characteristics--made no reference to ESG (including sustainability) in their fund name. This was the case for 29% of “dark green” article 9 funds, which are meant to have a sustainable investment objective.
“This result adds weight to the argument that article 8 has been used as a catch all category,” said the report. In January 2023, Morningstar research found that €175bn of article 9 funds had been downgraded, the majority of which ended up in the article 8 category.
Minimum sustainable investments missed
The European Securities and Markets Authority (Esma) in November 2022 released a consultation that aimed to implement minimum investment thresholds for article 8 funds that use ESG or sustainability-related terms in their names.
If a fund uses the words “sustainable” or any derived terms in its name, then 50% of the assets it invests in should be sustainable investments as defined in the Sustainable Finance Disclosure Regulation (SFDR), explained the Clarity AI report. 80% of the assets it invests in should be used to meet the ESG-related characteristics that it promotes, and 100% of the assets it invests in should follow the minimum exclusion criteria in the Paris-alignment benchmark regulation.
Clarity AI’s analysis, however, found that “only” 20% of article 8 funds with the word “sustainable” or a derived term plan to make sustainable investment of over 50% as laid out in the Esma consultation. In contrast, 95% of article 9 funds plan to do so.
85% of “sustainable” funds don’t comply with regulations
Very few funds meet the requirements for the different labels or categories under the regulatory frameworks of the EU, UK or US, found Clarity AI’s report. Only 15% of funds with “sustainability” in their name meet the criteria under the proposed regulatory frameworks with at least one of the proposed regulations, while 59% of funds with ESG-related terms do so.
Only 4% of sustainable funds comply with EU, UK and US regimes
Clarity AI dug deeper into the 15% of funds with sustainable or sustainability terms in their name and found that only 4% of these funds align with the conditions under the EU, UK and US regimes. That means 96% of them would require renaming or restructuring to sell across all three markets, found the report.
But requirements for funds with ESG-related terms were more consistent. Of the 59% of funds with ESG-related terms in their names, 85% of them complied with all three regimes--EU, UK and US.
Find the Clarity AI’s white paper “Overcoming Regulatory Confusion: A Study of EU, UK and US Sustainable Investment Fund Frameworks” here.