Providers wish to wait for planned SFDR review before making further fund reclassifications.
Despite recent attempts by lawmakers to provide more clarity on the EU’s Sustainable Finance Disclosure Regulation (SFDR), fund managers are reluctant to reclassify their Article 8 funds back to Article 9 after a series of downgrades.
Data and research provider Morningstar has analysed the Q2 2023 performance of the EU’s sustainable fund market, noting that the trend of downgrading funds from Article 9 to 8 has slowed, while Article 8 funds have struggled in an economy beset by volatility.
SFDR, first introduced in March 2021, requires asset managers with sustainable funds to categorise them as Article 8 (environmental and/or social characteristic) or 9 (environmental and/or social objective). Level 2, which came into force on 1 January 2023, requires asset managers to provide more detailed disclosures to justify these categorisations.
Mounting concern about greenwashing accusations due to ongoing confusion around Level 2 rules prompted asset managers to downgrade 350 Article 9 funds to Article 8 in H2 2022, Morningstar said.
In Q2 2023, 182 funds upgraded from Article 6 to 8, three upgraded from Article 6 to 9, and just six funds downgraded from Article 9 to 8, the report noted.
Hortense Bioy, Global Director of Sustainability Research at Morningstar, told ESG Investor that clarifications made by the European Commission in April “went some way” to providing managers with the certainty they needed to feel confident in their categorisations.
One of the most notable points made by the Commission was the confirmation that financial market participants carry the responsibility of defining sustainable investments but should disclose their methodology.
Of the assessed Article 9 funds, all but one has a sustainable investment target of over 80%, the report said. Mercer Passive Sustainable Global Equity has a minimum sustainable investment commitment of 35%.
Despite the reclassification slowdown, Bioy said the majority of managers are choosing to exercise caution.
“Based on conversations with asset managers, most of them want to wait for the Commission’s planned review of SFDR later this year before making any decision to reclassify their downgraded funds,” she noted.
“The priority for managers is to provide their clients with stability and certainty as to the degree of sustainability of their products.”
The Morningstar report also said that Article 9 funds attracted its “lowest inflows on record” in Q2, at €3.6 billion (US$3.9 billion), down from €4.4 billion (US$4.8 billion) in the previous quarter.
Article 8 funds suffered most in Q2, with them witnessing net redemptions of €14.6 billion, following inflows of €26 billion in the first quarter.
According to Morningstar, the redemptions in the last three months disproportionally affected the Article 8 funds with no commitment to sustainable investments, as these registered outflows of €9.8 billion, representing two-thirds of the total Article 8 outflows over the period, while funds with no minimum sustainable investments account for less than one third of the Article 8 fund universe.
While Article 8 funds saw their market share decline to 52.9% from 53.8% in Q1, Article 9 funds increased their market share to 3.5%, with their assets expanding by 7.8% over the past three months to €310 billion.
The organic growth rates (the growth of flows relative to assets) for Article 6 and 9 funds also increased by 0.3% and 1.2% respectively, while Article 8 funds shrunk organically by 0.3%.
Article 8 and 9 fund assets collectively passed the €5 trillion milestone for the first time.
Although the EU continues to dominate the global sustainable funds market, additional Morningstar research highlighted that “sticky inflation, rising interest rates, and recession fears continued to weigh on investor sentiment” across all jurisdictions.
In Canada, net inflows slipped to US$207 million from US$963 million between Q1 and Q2, while US-domiciled sustainable funds shed US$635 million and Japan saw net withdrawals of US$1.9 billion over the same period, Morningstar said.
Europe continues to make up the “lion’s share of the sustainable fund landscape”, the report added, with 84% of global sustainable fund assets. The US currently houses 11% of global sustainable fund assets (as of the end of June).
“Europe has a favourable regulatory regime in place,” said Bioy, noting that this will “continue to encourage sustainable product innovation”.