Regulators, asset managers, investment banks and investors are focusing much more on the sustainable credentials of products as they become more mainstream. However, several studies show that many do not live up to their marketing promises.
For example, a third of Europe’s Article 8 or 9 funds under the Sustainable Finance Disclosure Regulation (SFDR) had exposure to controversial weapons even before the outbreak of the war, according to Morningstar Direct data analysed by Citywire Selector.
Under the SFDR, asset managers need to report the EU Taxonomy alignment as part of the sustainability profile of funds.
Fund managers can classify their products by the degree to which they promote environmental, social and governance (ESG) goals.
Article 8 includes funds that are fully or partly focused on environmental, social or sustainability issues, while the more stringent Article 9 is fully dedicated to sustainable objectives.
In the meantime, those that are classified as Article 6 do not focus on sustainability.
Most of the funds invested in sustainability though are expected to avoid defence companies although some are looking at the returns being generated from Europe’s push to increase security spending due to the war in Ukraine.
For example, Sweden’s SEB Investment Management announced it had overturned a blanket ban on any company deriving more than 5% of its revenue from defence for six of its funds, although the majority of its product range is unchanged, including sustainable funds.
SEB attributed the change to pressure from customers for exposure to defence as Russian troops amassed on the Ukraine border, underlining that fund houses must answer to clients as well as their own sustainability promises.
Sustainable managers typically avoid businesses that earn 5%-plus of revenue from defence, while the vast majority of risk-focused funds just ban those involved with unconventional weapons such as cluster munitions.
According to Morningstar, sustainable funds have a 0.2% weighting to aerospace and defence against the Vanguard Total World Stock ETF’s 1.1%. In Europe the underweighting is starker — 0.2% against 1.6%.
Overall, questions over the Article 8 label have come to the spotlight in its first year of use. Recent analysis by Clarity AI found only 3.9% of the average revenues in these funds come from green activities.
Funds in the smaller pool of Article 9 had 15% of revenue as green.
In this context, green revenue is the percentage of sales generated from products that benefit the environment such as with cleaner water or contribute to mitigating climate change.
Clarity AI, a sustainability data technology platform part-owned by BlackRock, analysed 31,000 funds to assess how they perform against the EU Taxonomy.
The report acknowledged that complying with the EU taxonomy is not easy. It highlighted two main implementation challenges for investors.
The first is that there is a “clear mismatch between investor needs and available data. This discrepancy arises both in the timing, when investors need to start reporting before companies, and in the scope of the companies reporting—both EU and non-EU.”
The second hurdle is the ongoing regulation development process. It said that investors need to be ready to adapt as more objectives—both environmental and social—are defined.
Patricia Pina, head of product research & innovation at Clarity AI said the EU Taxonomy is a pioneer in setting a common standard to align a large segment of global market stakeholders.
“The EU taxonomy gives us a common language that will enable stronger decision making and an acceleration to a more sustainable economy,” she added.
“The EU recognises that a key requirement to further the development of the sustainable investment market is ‘access to high-quality sustainability-related data.’
She noted that this also means moving away from subjectivity and using an objective and fact-based definition of what should be considered green, social and environmental.
“Reliable, transparent insights are at the heart of fact-based sustainable finance. They should become the norm in making informed decisions around green investing,” said Pina.
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