The Sustainable Finance Disclosure Regulation (SFDR) is an EU regulation that hopes to make ‘sustainable investments’ more transparent. SFDR will essentially aim to tackle the greenwashing problem that is rife within the ESG space.

With the rise of ESG/sustainable/impact investing, many industry players have been trying to jump on the bandwagon. Consequentially many of the funds are not nearly as sustainable as they claim. Once trust is lost in the sustainable solution, it may take significant time to build it back up. With recent reports from scientists worldwide screaming alarm bells, time is the one thing we can be sure we don’t have in abundance.  

The regulator has stepped in to try and tackle some of these problems and put a structure around what does or doesn’t classify as ‘sustainable’. SFDR classifies funds into three baskets, labelled ‘articles’ Articles 6,8,9 descriptions are shown below.  

While this all sounds great, the issue arises when defining the specifics. Asset managers are eager to label their funds Article 8, or even Article 9, sometimes without the appropriate due diligence to ensure the fund truly qualifies. Some 15 of the largest asset managers in Europe have over 50% of their funds classified as Article 8 or 9.  

Asset managers each have their own way of interpreting the regulation, combining that with the race to be seen as the most green has been a recipe for greenwashing. Morningstar, a research and ratings provider have concerns that some funds “have simply formalised ESG exclusions… without making significant, or any, changes to the investment process”.  

As these anomalies with classifications emerge, combined with the macroeconomic outlook, net flows into article 8 funds turned negative in the second quarter of 2022. In other words, more money left article 8 funds than went into them. Article 6 funds, with no sustainability criteria, saw even more negative flows. However, when it comes to Article 9 funds, the most sustainable funds flows remained positive. It’s encouraging to see investors are still pushing for sustainable funds despite uncertainty.  

It’s not all bad news though, as the market is getting better at spotting greenwashing and a step up on the level of disclosure required by asset managers will come into effect in Jan 2023. According to Morningstar, some 16 funds have been reclassified from article 9 (dark green) to article 8 (green) as asset managers begin to feel the pressure to ensure that their funds are indeed as green as they say. This can only be a good thing for the investor, the quality of funds classified as Article 9 will become increasingly sustainable and the regulation will be there to make sure it stays that way.  

The introduction of SFDR is encouraging, as is the gradual increase in required disclosure. The more transparent sustainable investing is, the better it is for the individual investor, as well as for the planet. After all, that’s why investors continue to push for more sustainable investments!

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