SFDR reclassifications affect the European fund sector

After two false entries, one supposedly in January 2022 and another in July of the same year, now in January 2023 the application of Level 2 of the European Regulation on the disclosure of sustainable financial information (SFDR) will come into force.

The schedule was as follows:

• January 2022: Taxonomic declaration
• January 2023: application of the RTS (including SFDR information requirements for products in accordance with art. 8/9 SFDR)
• June 2023: Disclosure of the PIAs (Principles of Adverse Impact or PAI in English) for the information period between January 1, 2022 and December 31, 2022

According to FinReg360, the RTS project aims to:

• contribute to investor decision-making with reliable and comparable information on investments in “sustainable products” with an environmental objective, and
• collect in a single delegated act the information requirements of the disclosure and taxonomy regulations

A wave of reclassifications

Well, with the entry into force in January 2023, the managers have already begun to be somewhat more “prudent” with the self-reclassification of their funds in article 6, 8 and 9, thus marking a wave of classifications that has not been left behind. to the European ETF sector.

It is not surprising that a number of managers need to reclassify their funds and ETFs considering the SFDR, as they lacked clear definitions of the measures that would assign a fund or ETF to one of the three items. With the requirement to classify their funds prior to the publication of the respective regulatory technical standards, some managers may have been overly optimistic about their ESG credentials and ranked their products as high as possible, i.e. Article 9.

When the RTS was announced, fund managers realized that the requirements of European regulators for products assigned to Articles 8 or 9 were much higher than expected by most industry participants and market observers. In addition, fund managers and ETFs in Europe can expect market surveillance agencies in the EU to put more scrutiny into compliance with the RTS for the respective SFDR article.

Surprisingly, ETFs that track one of the two EU climate benchmarks (the Paris-Aligned Benchmarks and the Climate Transition Benchmarks) were not automatically classified as Article 9 products. classified as article 9 are reclassified as article 8 of the SFDR.

The shadow of “greenwashing” has hovered over this year, especially in the second half of 2023, so it is not surprising that the rules were stricter than expected for funds and ETFs to prudently classify their products.

However, these reclassifications are shaking up the respective market statistics and therefore may lead to some confusion until the end of the first quarter of 2023. In addition, the latest regulation proposal for the integration of ESG or derivative terms and/or related in the fund name will cause further distortions in the universe of sustainable funds. This is a significant reputational risk for asset managers.

As published by Citywire and Morningstar, in several of their notes, there is uncertainty regarding the funds classified as article 9 and what is sustainable investment under SFDR level 2. “Managers have downgraded the article 9 funds and have done so out of an abundance of caution, to avoid being accused of greenwashing, and they know that some of their Article 9 strategies will not meet the criteria for 100% sustainable investing, regardless of how sustainable investing is defined,” said Morningstar’s global head of sustainability research. , Hortense Bioy.

Additionally, according to what some heads of international management companies commented to Investment Strategies, this will bring a significant flow of assets, since there are many investors who bought these Article 9 funds thinking they were dark green and now those funds are light green, making it to expect significant outflows from these investment funds.

Among the managers that have reclassified funds from article 9 to 8 in recent weeks are:

• Morgan Stanley IM, having reclassified 4 funds that are MS INVF Sustainable Euro Corporate Bond, MS INVF Sustainable Global Credit, MS INVF Global Whited Sustainable and MS INVF Sustainable Euro Strategic Bond. These four funds add up to a total of about 120 million euros.
• Amundi, without knowing the exact number of funds, seems to have reclassified the majority that were article 9 to 8, considering some 45 billion euros.
• DWS, reclassified almost 2 trillion euros of funds article 9 to 8, among which are DWS Invest CROCI World SDG, DWS Invest SDG Global Equities, DWS Invest SDG European Equities, DWS Invest CROCI Europe SDG and DWS SDG Global Equities domiciled in Germany.
• Kempen reclassified 3 funds totaling around 880 million euros of managed assets, including Kempen Lux Sustainable Europe Small-Cap, Kempen Lux Euro Sustainable Credit and Kempen Lux Global Sustainable Equity.
• HSBC has downgraded 7 listed funds aligned with the Paris Agreement, such as HSBC MSCI Europe, Japan, USA, World, Asia Pacific ex-Japan and Emerging Markets Climate Paris-Aligned
• Invesco has also reclassified some exchange-traded funds such as MSCI Emerging Markets, Europe, Japan, USA and World ESG Climate Paris Aligned Ucits ETFs
• BlackRock also ranked 17 ETFs including iShares MSCI EMU Paris-Aligned Climate, iShares MSCI USA ESG Enhanced and iShares Smart City Infrastructure Ucits ETFs
• Robeco also announced in October that it would reclassify seven Article 9 strategies
• Axa IM, according to a Morningstar article, had already reclassified 21 strategies recently and planned to reclassify another 24 strategies.

4.3% of European funds at the end of 3Q22 were article 9 funds

According to the Morningstar report prepared by Nortense Bioy, at the end of the third quarter of the year, 33.6% of EU funds declared “promoting environmental and/or social characteristics” (article 8), while 4.3 % claimed to have “a sustainable objective” (article 9). The rest are funds (article 6) that declare that they do not have ESG characteristics.

In terms of assets, Article 8 and Article 9 funds represented a larger proportion of the EU universe: 53.5% combined, divided between 48.3% for Article 8 funds and 5.2% for funds of article 9.