The wave of fund reclassifications at the end of last year left the Article 9 space significantly smaller both in terms of assets and number of funds, and the highly visible debacle left some commentators warning that the credibility of SFDR itself was at stake.
The rush for Article 8 was sparked by a lack of clarity in two areas.
The first was uncertainty over whether passive funds tracking one of the EU’s Paris-aligned or Climate Transition benchmarks automatically qualified as Article 9. The second revolved around the definition of a sustainable investment, as an earlier Commission statement had indicated that Article 9 funds should invest all of their assets in sustainable investments.
With more than 350 funds potentially eligible for a re-upgrade, there is significant possible movement in the market.
However, only one asset manager has so far broken cover to re-upgrade its funds. Handelsbanken, which downgraded seven Article 9 passive funds to Article 8 last year, said in its Q2 report that it had decided to reclassify them again to Article 9 after receiving the clarifications in May.
Adeline Diab, managing director for ESG research at Bloomberg Intelligence, said she was “quite surprised” by the drop in reclassifications in Q2 of this year. Her figures show an 80 percent drop in funds changing their classification under SFDR.
Managers’ inertia is attributed to a combination of continuing uncertainty around SFDR, awaited guidelines from regulator ESMA on fund naming, and a lack of clear commercial advantage to report under Article 9.
The European Commission is preparing a review of the regulation, expected later this year, and the final version of ESMA guidelines on ESG and sustainability terms in fund names is also due in the autumn. Both moves could have major implications for the classification of funds.
For DWS, which downgraded a number of its active Article 9 funds and 10 Paris-aligned Benchmark ETFs, the current decision is to stay at Article 8. Dennis Hänsel, global head of ESG advisory, told Responsible Investor it was partly “due to the fact that we did not observe a huge change in flows due to the conversion”.
The possible reclassification of active funds will wait “until it’s clear what is happening”, he said, adding that DWS still has concerns about Paris-aligned and Climate Transition Benchmarks. The manager bases its share of sustainable investments in a fund around company activity, and its PABs and CTBs have a figure around 25 or 30 percent.
Hänsel said it was a “little odd”, then, that the threshold in ESMA’s consultation was 50 percent.
Raza Naeem, a partner in Linklaters’ financial regulation team, said that while the status of PABs and CTBs is more settled than that of active funds, investors may still want to see what SFDR looks like before making another move. Too many changes could pose a credibility issue, he added.
In Naeem’s experience, there is also relatively little commercial benefit to reporting under Article 9.
“Clients have generally been wanting Article 8 or 9, although there has been more limited interest in Article 9 specifically,” he said. “That said, some investors do want Article 9 and certain managers have appetite for them to support their ESG strategies. Generally investor feedback seems to be equal happiness with either Article 8 or 9.”
Diab disagreed slightly. While the relatively undifferentiated mass of Article 8 funds means there is unlikely to be a commercial advantage in that area, she said, “I do think Article 9 has a commercial relative attractiveness”.
“This is where funds labelled as Article 9 need to demonstrate processes, transparency and alignment to commitments because that’s where the scrutiny will be first,” she added.
Article 8 aches
While the Article 9 space has quietened down for the moment, there is still some unease in the market around Article 8 funds. The latter currently account for around $6 trillion in assets and a significant proportion of funds by number in the European market report against Article 8.
Article 8 continues to serve as a “catch-all everything and nothing” category for sustainable funds, Diab said. “I don’t know how a client or investor can make an informed decision, or how Article 8 can give them an indication of the quality of the fund or for the strategy they’re seeking.”
Some funds offer Paris-aligned solutions, others are “robust” ESG funds, and then there are some money market funds in the category, she added.
Given regulatory scrutiny of sustainable funds, and the incoming ESMA guidance, Diab echoed predictions that some managers may ditch the category entirely.
“I would expect more Article 8 downgrades in the future,” she said. “I think it would be helpful for the EU Commission to address the uncertainty around Article 8 in the upcoming review of SFDR.”
Asked whether Article 9 funds currently sitting at Article 8 presented a “green hushing” risk, Naeem said there was still a level of transparency.
“If you’re an Article 8 product, you’re still disclosing under SFDR. Therefore you aren’t getting rid of transparency, you’re being clear on your commitments and promises but you may not feel comfortable taking on that level of Article 9-related risk.
“From a commercial and marketing perspective, I think there is more caution because of the focus on greenwashing. Firms should be able to say they’re not comfortable taking on that level of regulatory risk or the compliance implications that Article 9 funds require.”