Last week, European Fund Managers down-graded nearly €50 billion worth of investment funds on grounds of sustainability.
In total, nearly 10% of the premium rated sustainable funds have moved their rating down a notch since early November. And these are not peripheral players. Among the fund management groups to make these moves have been Amundi, Blackrock, UBS and HSBC
Regulators now require investment funds to be ranked on how well they adhere to environmental, social and governance factors. The fund managers who down-graded felt that a wide range of their funds which had previously held to the higher sustainability regime (so-called Article 9) didn’t meet the required criteria.
This is fund managers reassessing their own funds to see if they measure up. It is part of a broader reclassification drive in the European asset management industry ahead of the implementation of new measures at the start of next year. We may well see more downgrades
Just to recap: At a very high level, European regulation requires that funds classified as Article 9 funds in the new legislation are those funds, which can invest in a wide range of assets across equities, bonds and real assets ,that specifically have sustainable goals as their objective. The next category would be Article 8 funds which are somewhat more “relaxed” i.e. those funds that promote ESG characteristics but do not have them as the overarching objective.
Fund managers clearly don’t want to risk the ire of the regulator and “over promise” on the sustainability of their funds. The Central Bank in Ireland has affirmed that standards must be high. This is leading to a deliberately cautious approach from some fund managers.
Other fund management groups who had declared their funds as Article 9, on reflection feel that a more restricted universe of sustainable investments would lead to holding less stocks, meaning poorer diversification in the final portfolio – adding to greater investor risk.
As the Central Bank points out, the criteria used, and the rankings applied, need to be constantly assessed. Looking through an ESG lens can have significant impact on company evaluation. Moodys estimate that the credit impact of ESG considerations is highly negative for about 20% of a 6000 company universe they analysed. So transitioning from one level to another is not straightforward.
There is also a need for investors and agencies to drill down into how companies are assessing themselves. Cop27 jumped on this issue and demanded a stop to “dishonest climate accounting” where companies relied too much on buying questionable carbon credits rather than cutting their own emissions.
This is a new area and likely to be fluid for some time. There can often be lack of consistency in terms of how individual companies are rated by third party providers, and indeed managers may apply their own interpretations as to how “sustainable” companies may be.
This inconsistency and lack of common language is also apparent in the drive to Net Zero. We learned at Cop27 nearly one third of the largest companies now have a Net Zero vow. While this is higher than the 20% figure we saw at Cop26, it is totally undermined by a lack of robust rules.
According to UN Secretary General Antonio Guterres, this lack of rules and consistency has left “loop-holes big enough to drive a diesel truck through.”
We are at the beginning of this process. As at July 2022, the Central Bank estimated about 2% of Irish funds are at the elevated Article 9 level with about 25% at Article 8.
There seems no end to the wave of marketing material from fund management groups currently. They display very detailed schematics showing how investment management and sustainability factors seamlessly blend into a proven process – often under a Head of Sustainability recently appointed! All fund management groups strive to emphasise their difference.
We will see more changes in this funds sector and the amount of assets invested along these lines will grow. It is right that fund management groups should ensure their funds are “in the right sustainability box”. The Central Bank has insisted that all fund names and literature are consistent, clear and constantly under review.
This is how it should be.
Tradewinds 