Dedicated green and social bond funds face SFDR uncertainty

Some funds investing solely in ESG debt were downgraded last year as other managers take a cautious approach to initial classification.

Uncertainty around fund classifications under the EU’s sustainable finance disclosure regulation (SFDR) is even affecting the classification of dedicated green bond funds, with managers unsure or cautious about designating their funds as Article 9.

A report by ESG advisory firm Mainstreet Partners found that 37 percent of funds dedicated to investing in green, social or sustainability bonds were classified as Article 8, with the remainder as Article 9.

As with the wider universe of Article 8 and 9 funds, managers have been taking a varied approach to classifying and reclassifying their GSS bond funds. When Amundi downgraded almost all of its 100 Article 9 funds, with assets of more than €45 billion, that included many of its green bond funds.

While the firm’s flagship €869 million impact green bond fund retains its Article 9 designation, as does its social bond fund, its emerging market green bond fund holds the Article 8 classification.

There is a similar contrast in effect among the range of ETFs offered by Lyxor, now integrated into Amundi. Three of its dedicated green bond ETFs were downgraded to Article 8 in December last year, while its euro-denominated government green bond retained its Article 9 status.

Amundi did not respond when asked how it decided on the classification of its GSS bond funds.

In contrast, dedicated GSS bond funds at other managers have been the only ones to retain Article 9 status. BlackRock’s green bond ETF was the sole survivor from its ETF range, while NN IP’s GSS funds also kept their Article 9 status despite the firm being one of the first movers in the wave of downgrades.

Other managers have been more cautious, classifying their GSS bond funds as Article 8 from the start.

When asked about the classification of its Rivertree Green Bond fund, a spokesperson for Quintet said: “While one could argue that this fund – like all green bond funds – may merit Article 9 classification, the regulation itself was of course only recently introduced and remains subject to a certain degree of interpretation. We therefore deemed it prudent to take a conservative approach to classification.”

Vladimir Danesi, head of multimanagement and ESG at Swiss Life Gestion Privée, told Responsible Investor that from reading Q&As from European regulators in July 2021, before classifications came into effect, “it was quite clear for us that the requirement to fulfil Article 9 was to be fully invested in sustainable investment”.

Swiss Life’s green bond fund has a minimum requirement of 90 percent of assets to be invested in green bonds, with no restrictions on the remaining 10 percent. With this in mind, Danesi said: “We consider that we do not fulfil the ‘fully invested’ requirement.”

The firm will be evaluating whether it can introduce sustainability restrictions on this 10 percent, with an eye to possibly upgrading to Article 9. However, Danesi said “we are very aware of not greenwashing and we clearly prefer having ‘underclassified’ funds and then upgrading properly rather than in the beginning having Article 9 and then being obliged to downgrade”.

Fund flows and data disputes

Hortense Bioy, global director of sustainability research at Morningstar, told RI that, according to her data, green bond funds had fared well in the wave of Article 9 downgrades, with the “vast majority” retaining their status.

“The EU regulator has yet to clarify a number of points regarding the definition of sustainable investment, but it seems to be clear in most asset managers’ minds that green and social bonds meet the SFDR definition of sustainable investment,” she said.

“If these bonds do not qualify for Article 9, then the question is: what does? And there wouldn’t be any point having an Article 9 category.”

Research by GIB Asset Management ahead of the launch of its sustainable bond fund – which is not a dedicated GSS fund – showed that there are relatively few bond funds in the Article 9 universe.

Samantha Lamb, the firm’s head of fixed income, told RI: “Large fund managers have had to retroactively integrate ESG into their funds and investments and to do so was a very top-down process, often relying on third-party data providers/classifications. Therefore integrating sustainability at the very outset of the investment process in fixed-income is much more challenging.”

Even with green bonds, it is “appropriate to take a sceptical lens to labelled issuance”, Lamb continued, “in the same way that active investment teams assess everything that companies state”.

Aside from the reputational risk, it is also unclear whether having an Article 9 classification is beneficial in terms of increased flows. Lamb said that, as we are “still waiting for the dust to settle”, it is too early to tell what effect it has had on flows.

Danesi noted that external market conditions had also played a role. “Mainly due to the fact that 2022 was a tough year in the markets, our clients’ main concern was more performance than the [sustainability] quality of underlying investments,” he said, “but I hope this will change and we reach both goals this year.”

Bioy also forecast that investors will look beyond the Article 8/9 classification. “The percentage of sustainable investment – which cuts across A8 and A9 – will become the focus for investors who want to invest sustainably,” she said.

“There are, however, still issues with the way these percentages are calculated. Methodologies vary due to the different interpretations of SFDR taken by asset managers.”