‘Potential greenwashing concerns’ over Global Compact and OECD violators in Article 9 funds

Analysis into drivers of inclusion in Article 9 funds shows high presence of UNGC violators, suggests ESG ratings drive inclusion more than emissions.

Researchers at the University of Zurich have noted “potential greenwashing concerns” over the presence of more than 300 companies in violation of the UN Global Compact or OECD guidelines in a sample of Article 9 equity funds in a new working paper. 

Marc Chesney and Adrien-Paul Lambillon, both researchers at the University of Zurich Centre of Competence for Sustainable Finance, conducted an analysis of holdings in a sample of 290 pure equity Article 9 funds with either a global, Europe, US or emerging markets focus. Each company in a fund is assigned a “greenness score”, calculated according to the number of funds in the sample it appears in. 

Article 9 funds are the most ambitious tier under the EU’s anti-greenwashing Sustainable Finance Disclosure Regulation (SFDR) legislation, requiring funds to prioritise ESG outcomes. 

The analysis focused in on global funds, which held 4,463 different companies between them. Of these companies, 1,544 appear in only one fund, with industrials, financial services firms, and tech, media and telecoms companies the most popular sectors. 

Far and away the most popular company is French electrical power equipment firm Schneider Electric, which features in more than half of global Article 9 equity funds, while Vestas appears in 47 percent and Microsoft and US water tech firm Xylem are both in 39 percent. 

Though renewables companies are more popular than oil and gas companies, appearing in a higher proportion of funds, there are numerically more oil and gas firms in Article 9 funds than renewables, at 98 versus 72. There are 312 companies in violation of the UN Global Compact or OECD guidelines, according to Bloomberg data, which feature in global-focused Article 9 funds in the sample. 

Inclusion in an Article 9 fund is “significantly driven” by corporate sustainability efforts, including climate targets, human rights policies or better ESG ratings, the researchers find, with actual emissions intensity levels less likely to result in inclusion. The former factors favour the more frequent inclusion of larger corporations, they say. 

The researchers particularly note the pronounced correlation between a company’s MSCI ESG rating and its greenness score, but question the utility of an Article 9 fund relying on the MSCI ratings because they measure ESG risk not impact. However, they say this may change in future as more companies report on their alignment with the EU taxonomy, providing an alternate data point. 

Having a science-based net-zero target also has a “significant statistical and economic effect” on a company greenness score, the research found. However, the authors question to what extent setting a net-zero target means that a company should be seen as a sustainable investment for the purposes of SFDR. 

Companies with a negative environmental or social impact can commit to science-based targets, and thus increase the frequency in which they appear in Article 9 funds, especially among Climate Transition and Paris-aligned Benchmarks. 

While funds can hold these negative impact companies with a view to contributing to their transition through engagement, they might also hold them for financial performance and diversification purposes. This latter aim “would indicate potential greenwashing motivations”, the researchers continue. 

There is also some concern over the widespread inclusion of financial services companies, which are especially prominent in regional funds. While these companies may have low emissions, some banks’ high financed emissions or financing for controversial companies could raise issues. 

The main analysis of fund holdings was carried out before the “Great Declassification” of Article 9 funds, and roughly 40 percent of the funds in the researchers’ sample lost their Article 9 status. This is in line with the wider Article 9 market. 

Excluding the declassified funds from the sample cuts the number of companies featured in at least one fund by 1,702, as well as excluding 132 of the 312 UN Global Compact violators. 

The researchers say that their results “raise doubts on the adherence [of Article 9 funds] with the SFDR’s principles of Do No Significant Harm and sustainable investments”. 

Funds are required to disclose the integration of sustainability factors into their investment processes under SFDR, and while these disclosures “may seem promising, our results suggest that the resulting portfolios are less promising, as they are affected by the size effect and large companies’ corporate sustainability efforts”. 

“Investment and sustainability processes seem to be established with the aim of not limiting the investable universe too much, and still have the flexibility to include companies in sectors less characterised by positive environmental or social impact, such as the financial services sector, or in some cases even controversial sectors, such as the oil and gas sector or the controversial weapons industry,” the researchers wrote.  

“The resulting investment portfolios may therefore be viewed by observers with the criticism of ‘tout ça pour ça?’ [all this for what?].”