SFDR credibility ‘at stake’ as trickle of Article 9 downgrades grows to a flood

More than a tenth of funds bearing the EU's highest sustainability designation have been downgraded in November as managers prepare for 1 January.

The slow trickle of Article 9 funds downgrading to Article 8 amid uncertainty over the EU’s Sustainable Finance Disclosure Regulation (SFDR) has grown to a flood.

More than a tenth of all Article 9 funds – just under 130 – have announced plans to ditch the classification since the start of November. These include many ETFs tracking Paris-aligned (PAB) and Climate Transition benchmarks (CTB).

Morningstar data from the end of Q3 this year showed that 1,080 funds in total had classified themselves as Article 9, making up 4.3 percent of the EU fund market in numbers and 5.2 percent in assets.

Guidance issued by the European Commission in July indicated that 100 percent of assets in an Article 9 fund must be sustainable, but clarification on exactly what qualifies as a sustainable asset is still missing, leaving many managers uncertain as to whether their funds qualify. The status of a Paris-aligned or Climate Transition benchmark also remains uncertain. The pace of downgrades is accelerating ahead of 1 January, when more stringent Level 2 disclosures come into force.

The bulk of the changes have come from Amundi, which said in a statement it had decided to take “a conservative approach” in terms of fund classification, ditching the Article 9 classification for “almost all” of its 100 funds in the category, which between them manage €45 billion.

The French asset manager said the current regulatory framework “does not yet allow the financial industry to respond in a uniform manner as to what should be considered sustainable or not”. It added that its deliberately cautious approach “is in response to Amundi’s concern for protecting investors and distributors from a significant risk of confusion in the allocation of savings”.

BlackRock has also downgraded all but one of its Article 9 ETFs to Article 8, for a total of 16 funds with $26 billion in managed assets. This includes its flagship iShares Global Clean Energy ETF, which has $6.2 billion. Responsible Investor understands that some constituents of the index tracked by the clean energy ETF have legacy extraction businesses, which means the fund fails to meet the 100 percent sustainable investments requirement.

Also among the BlackRock funds dropping the classification is the USA ESG Enhanced ETF, which tracks an MSCI Climate Transition Benchmark and has close to $11 billion in assets. Four other ETFs with more than $1 billion have also been downgraded, with the sole survivor at Article 9 level a green bond ETF.

BlackRock has also taken the unusual step of downgrading an Article 8 fund to Article 6. The iShares Refinitiv Inclusion and Diversity UCITS ETF, which has just under $70 million in assets, will next month become only the second Article 8 fund to date to lose the designation.

Other managers to make changes to Article 9 funds include HSBC, which has downgraded six Paris-aligned Benchmark ETFs, including an MSCI world ETF with $168 million, and Invesco, which has reclassified five of its seven Article 9 ETFs, including a $107 million MSCI Japan PAB. The two survivors are thematic ETFs investing in wind and hydrogen.

UBS Asset Management has also reclassified “a small number” of PABs, claiming in a statement that it was “in the best interests of shareholders”.

A spokesperson for Invesco said that at the launch of its products the understanding was that they qualified for Article 9. “However, with recent clarificatory points raised with the EU Commission on fundamental interpretation points, we have concluded that it was more appropriate to reclassify our five Paris-Aligned UCITS ETFs to Article 8 until these outstanding questions have been clarified,” they said.

HSBC Asset Management declined to comment.

Raza Naeem, a partner in Linklaters’ financial regulation team, said the continuing uncertainty “does impact on the credibility of SFDR”.

“It shows that instead of the European regulators making piecemeal changes to issues, it would have been much better for them to make all the rules properly once as opposed to trying to rush through it,” he continued.

While managers are currently downgrading their PABs and CTBs given the lack of current clarity, Naeem said that guidance would likely eventually clarify that both labels do qualify for Article 9.

“Surely Europe has to think that its own super green benchmarks are sustainable,” he added.

David Thomas, a managing associate in the law firm’s dispute resolution team, said that when considering possible legal and compliance issues “what is most important is that managers are comfortable that the classification of the fund is correct”.

“If you’ve got a change in the rules or guidance that alters the position or introduces some significant uncertainty then downgrading the fund might be the right thing to do and will mitigate the risk of criticism going forward,” he said.

“However, the downgrade itself is not risk-free, because if investors thought they had an Article 9 fund and now they don’t, that alone might be a cause for concern or complaint. That’s not a reason not to do it, but it does mean that there’s a slightly tricky path with some risk on both sides.”

Hortense Bioy, global director of sustainability research at Morningstar, said there was an “urgent need” for clarification from EU authorities on sustainability criteria.

“The situation is a bit chaotic at the moment as asset managers are waiting for the European commission to clarify the definition of ‘sustainable investment’,” she said. “They know that some of their Article 9 strategies won’t meet that criteria regardless of how a sustainable investment is defined, so they have decided to downgrade these strategies to Article 8.”

She also called for clarification on what methodologies are acceptable to calculate portfolio exposure to sustainable investments.

“The credibility of SFDR and the whole asset management industry is at stake here,” she added. “We can’t ignore the fact that some investors have invested in these Article 9 funds thinking they were ‘dark green’ strategies. Even if these strategies haven’t changed and the portfolios remain the same, the perception of the ‘greenness’ of these strategies will change.”