The European Securities and Markets Authority (ESMA) issued another greenwashing warning to investors last week, in its latest report on Trends, Risks and Vulnerabilities.
The supervisor discussed one of the biggest challenges for the Sustainable Finance Disclosure Regulation (SFDR) – its use as a label.
Introduced in 2021, the rule was meant “to reduce information asymmetries” between fund providers and clients about how products address sustainability risks and impacts, “by requiring financial market participants and financial advisers to make pre‐contractual and ongoing disclosures to end-investors when they act as agents of those end-investors”.
The most famous part of SFDR is the requirement for fund providers to explain whether their product promotes environmental and social characteristics (an ‘Article 8’ fund) or pursues a sustainability objective (an ‘Article 9’ fund).
By the end of last year, Morningstar data showed that more than half of all UCITS fund assets were disclosing under Article 8 and 9.
But the trend has gone beyond disclosure. As ESMA pointed out in its report last week: “In the absence of an EU-wide labelling regime for ESG funds, some managers have also used Articles 8 and 9 as proxy labels for communication purposes.”
Asset managers are marketing funds to potential clients, media and other stakeholders using the EU categories as proof that they are sustainable, despite the fact that they are currently self-identifying and there is no definition attached to either category.
There are widespread concerns that such claims give the impression that the funds have received a stamp of approval from the EU for meeting certain standards.
“SFDR was not intended to be a labelling regime and does not include the type of requirements usually attached to voluntary labels, prompting further concerns of potential greenwashing,” said ESMA. “The misuse of SFDR as a marketing tool could create potential risks to investors as demand for sustainable products remains strong.”
The European Commission has expressed the same concerns. In December, commissioner for financial services Mairead McGuinness told European parliament that confusion over the purpose of the SFDR was one of the biggest hurdles for policymakers working on the sustainable finance agenda in 2023.
ESMA said some of the challenges “would merit adjustments” to the regulation, and the Commission is undertaking a full review of the rules. It will publish its findings by the end of the year.
Next week, ESMA will close a consultation on plans to introduce guidelines for funds wishing to use words like ESG in their titles. It seems likely that if those guidelines move ahead (they are part of the Cross-Border Distribution of Funds Directive) they will become the basis for labels, addressing the “absence of an EU-wide labelling regime for ESG funds” that ESMA thinks is contributing to the misuse of SFDR.
However, given that the guidelines – which currently suggest funds must invest at least 80% of their capital in assets that align with their term they are using – rely heavily on definitions and concepts set out in SFDR, there are also concerns that they will have the opposite effect, and be interpreted as standards against which to enforce the adoption of Article 8 and 9.
Some of the national bodies tasked with enforcing SFDR on behalf of the EU want these kind of standards.
Earlier this week, France’s National Competent Authority, the AMF, proposed “the introduction of minimum environmental requirements” for Article 8 and 9 funds.
AMF explained that savers may interpret the categories “as a guarantee that they are participating in the financing of a more sustainable economy”.
Rather than intervening to stop Article 8 and 9 being used labels, AMF argued that the European Commission should just establish rules for the two categories, which could include divestments from fossil fuels and alignment with the EU taxonomy.
The chair of the AMF, Marie-Anne Barbat-Layani, discussed the proposals with Commissioner McGuinness last week, but it remains to be seen whether they will be picked up.
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