‘Dark green’ Article 9 fund upgrade fails to materialise

A clarification provided by Brussels on the application of the Sustainable Finance Disclosure Regulation has not led to the wave of fund upgrades many expected.

More than 300 funds were downgraded from “dark green” Article 9 — which must explicitly follow a sustainable investing strategy — to Article 8 in the final quarter of last year.

The downgrades to Article 8 — which must promote sustainable or environmental characteristics but do not have sustainable investing as a core objective — was mostly the result of gaps in regulation, experts said at the time.

In April, the European Commission issued a statement on how asset managers should determine whether investments were sustainable or not, providing asset managers with greater regulatory flexibility.

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The intervention was expected to lead to a large number of Article 8 funds upgrading to Article 9, but the wave has failed to materialise.

Just 35 funds have made that upgrade so far this year, including 15 in the third quarter, according to Morningstar data.

Hortense Bioy, global director of sustainability research at Morningstar, said most managers of Paris-aligned benchmark and climate transition benchmark passive funds did not view upgrading Article 8 funds as essential.

Some managers were actively engaging with regulators and the market in order to decide whether to upgrade funds or not, while others were opting to wait for the SFDR review, which was released in September as a consultation paper and potentially signalled a “comprehensive overhaul” of SFDR, said Bioy.

Raza Naeem, partner at Linklaters, said SFDR was still in “a state of flux”, which explained why the current rate of reclassification was “quite low”.

“[Managers] are particularly mindful of SFDR [ . . . ] reviews, which will invariably lead to a further tightening of standards,” he added.

Naeem said he expected the number of reclassifications to rise following the release of the final version of the European Securities and Markets Authority’s guidelines on the use of environmental, social and corporate governance and sustainability terms in fund names, which could potentially have a “major impact” on fund classifications.

Detlef Glow, head of research for Europe, the Middle East and Africa at Refinitiv Lipper, said the SFDR product classifications were still “a moving target” for funds.

Glow said the lack of a standard definition for what constituted a sustainable investment made it hard for asset managers to settle on one product categorisation.

Managers also remained “cautious” and were hesitant to upgrade their funds, fearing the impact on investor experience and their credibility, in case “the EU-level position changes”, said Naeem.

Bioy agreed, saying most managers were concerned about “clients not understanding the flip-flopping”.

Even if managers withheld from upgrading the funds, there was no “commercial pressure” to reclassify them, given that investors had not expressed dissatisfaction with the downgraded funds, said Bioy.

Bioy noted that inflows into the 300 funds that were downgraded in the last quarter of 2022 were 40 per cent higher than those into Article 9 products over the first nine months of 2023.

Funds that were downgraded from Article 9 to Article 8 before 2023 have previously had lower inflows than Article 9 funds.

Ottilly Mould, sustainable finance lead at consultancy Nordic Sustainability, said there was still a “high barrier” to SFDR due to its “complexity and inaccessibility”, driven by the lack of a standard definition for what a sustainable investment is.

“The sheer volume of conflicting guidance is enough to put people off,” she said.

However, some fund managers had “taken comfort” from the commission’s clarification to re-upgrade their passive funds, such as Handelsbanken and Ossiam, said Naeem.

*Ignites Europe is a news service published by FT Specialist for professionals working in the asset management industry. Trials and subscriptions are available at igniteseurope.com.