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'The great reclassification' strikes Article 9 funds as second SFDR phase approaches


The question has been raised following the recent spate of reclassifications, although the onus will be on fund providers to make any “downgrade details clear” in order to avoid mis-selling accusations.

More than 1,500 Article 9 funds at risk of losing status

In recent weeks, Amundi, BlackRock, Axa, Invesco, NN Investment Partners, Pimco, Neuberger Berman, Robeco and Deka have all downgraded ‘dark green’ Article 9 funds to ‘light green’ Article 8 status in preparation for the European Union’s next Sustainable Finance Disclosure Regulation deadline, in what is being dubbed ‘the great reclassification’.

SFDR, which came into effect in March 2021, will move to the next phase in January 2023 with the implementation of level 2 rules. These aim to bolster the reporting requirements for sustainable and ESG-labelled financial products.

Elly Dowding, co-founder of ESG Accord, said she expects “most of the panic is over and the bulk of downgrades have now happened”, with the caveat that “there may be a smaller batch of last-minute downgrades once the reality of making the disclosures sets in”. Patricia Volhard, partner at Debevoise & Plimpton, was less sure due to the uncertainties around the definition and scope of ‘sustainable investments’, adding that “much will also depend on the responses of the Commission to the ESA’s questions raised in that regard a few months ago”.

Patrick Reed, co-founder and CEO of YourStake, predicts the “trend of downgrades” will continue.

“There will continue to be many downgrades of Article 9 funds prior to January, but this mainly is due to confusion around what the EU will finalise for what ‘sustainability’ is,” Reed said. “The recent delay only adds to the confusion.

“Often these downgrades are due to a lack of data on their sustainability practices, and this will take time to build a full picture due to the multi-part adoption of SFDR.”

Fears of greenwashing allegations

The boom in the sustainable investment market in recent years has created two tiers of sustainable strategies, Julia Dreblow, founding director of SRI Services, said; the more established funds and “those [that] are perhaps more opportunistic, many of which are passive funds”.

Amundi downgrades €45bn of Article 9 funds

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With the new entrants to the market looking to upskill to avoid greenwashing allegations, Dreblow argued the reconsideration by many managers has been the right move, with more likely to follow.

Although greenwashing concerns remain elevated, Dreblow suggests “newer managers” may have fallen foul of greenwashing inadvertently.

“A not insignificant proportion of newer managers have neither reflected the seriousness of the environmental and social challenges we face, or their clients’ desire for change in their strategies,” she said. “Although managers and marketers of such products may have believed their messaging and the classifications they have adopted, many have rightly been called out for greenwashing.”

Rory Sullivan, CEO of Chronos Sustainability, countered that many fund providers moving products from Article 9 to Article 8 are doing so to avoid potential greenwashing accusations or “overclaiming their green credentials” and are striving to be classified appropriately.

Dowding suggested there would not be grounds for mis-selling provided the fund managers “go above and beyond to make the downgrade details clear”.

“As the initial rush to Article 9 was partly fuelled by the initial, less prescriptive qualification requirements, fund managers can point to the changing regulatory environment as the main reason for deciding the downgrade,” she added.

Volhard goes one step further, asserting fund providers should have been clear about the potential for reclassification in their prospectus documents.

“The key here is how well fund sponsors managed their pre-contractual disclosures and PPMs. If they were sufficiently clear that there was a risk that a downgrade may be necessary due to new guidance and administrative views, then any risk of mis-selling claims should be manageable,” she said.

Flow patterns

Flows into Article 9 funds have held up recently against their lighter green counterparts. According to Morningstar Direct, Article 8 funds saw €28.7bn in the third quarter, while Article 9 products registered €12.6bn in net inflows in Q3.

Thirteen Article 9 funds hold fast fashion brands under government investigation

“Research has shown for many years a significant proportion of clients want to invest in companies that are helping to drive us towards a sustainable future,” Dreblow said. “The FCA’s 2020 Financial Lives survey put this figure in the region of 70-80%. Many funds have fallen far short of this, clinging to relatively conventional benchmarks and tracking error measures – rather than seeking to truly understand and respond to clients’ sustainability preferences.

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“Funds can expect to be rewarded or punished accordingly.”

Reed agreed that downgraded Article 9 funds could see outflows but suggested flows would be reinvested in other Article 9 funds.

“It would not be out of expectation that outflows [from downgraded funds] would happen in the short term, and one could assess that the reason for Article 9 inflows is due to the shift in assets from downgraded products to steady Article 9 funds if the investor is focused on a deep green fund in their portfolio,” he explained.

This poses the question of whether the Article 8 category is at risk of being swamped following the spate of Article 9 downgrades or whether assets will be redistributed by investors.

According to Morningstar Direct, as of 30 November Article 8 funds comprised 49.2% of the SFDR universe – in terms of market share of total net assets – and Article 9 funds represented 5.3% of the total.

By comparison, at the end of September, 48.3% of these funds’ assets were classified as Article 8 and 5.2% were classified as Article 9, according to Morningstar’s report, ‘SFDR Article 8 and Article 9 Funds: Q3 2022 in Review’, representing only a slight shift.

This may not come as a surprise to Dowding, who said: “As disclosure rules inevitably increase over time, further downgrades to Article 6 are likely.”

Similarly, Morningstar analysts are also anticipating further downgrades. “In light of all these recent developments and in expectation of further downgrades, we can expect the number of Article 9 products to decline in the next six months,” the Q3 report read.

Sullivan agreed Article 8 will become “very crowded” as most large investors and investors with responsible investment teams will be able to meet the Article 8 requirements, while RLAM’s head of responsible investment, Ashley Hamilton-Claxton, suggested the category will become inefficient.

“The impact of the recent downgrades from Article 9 simply creates a challenge in the Article 8 category. The category is now so broad and diverse, it will be exceptionally difficult for consumers to navigate.”

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Next SFDR tranche

Dowding predicted the upcoming SFDR shift will be welcomed by fund managers “in terms of greater clarity” and by investors “in terms of greater transparency”, while Volhard is more phlegmatic, on the grounds it is “difficult to talk in terms of success or otherwise”. She said: “Rather, the thing to focus on is the industry complying with the regime and managing investor expectations.”

Hamilton-Claxton is more damning of the regulators’ inconsistency in implementing SFDR.

“The challenge asset managers are facing with SFDR is that the regulation is exceptionally unclear and the guidance coming out from the regulators keeps changing, often at the last minute,” she said. “When faced with moving goal posts, there will of course be some adjustments to how asset managers are interpreting and implementing the regulations.”

Thomas Willman, senior product specialist at Clarity AI, was critical of how the level 2 rules are playing out but said the future is positive for Article 9 funds that can meet the reporting requirements.

“I think it is a poor outcome for the industry,” he said. “There is reputational risk for asset managers. Distributors will want to be confident the funds they are distributing do exactly what they say on the tin. And finally, the investors at the end also want to be able to invest with some degree of certainty and be sure their preferences and demands are being met.

“It is also a big opportunity. Being able to confidently and assertively market funds as Article 9 opens up a lot of opportunities for asset managers to meet the growing demand for ESG-related funds in the industry. And the potential premiums that might come along with that.

“There are also savings to be made in terms of compliance costs, and avoiding unwanted supervisory or regulatory attention. The result of that is both regulatory and reputational risk can be reduced.”

This article first appeared on Investment Week sister publication Sustainable Investment.



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