New research suggests lack of alignment disclosure due to “incomplete nature” of taxonomy and “high bar” for determining sustainable activities.
In the absence of sufficient corporate disclosures, fund managers are failing to disclose the extent to which their EU-domiciled sustainability-labelled products are aligned with the environmental objectives of the EU taxonomy.
This is according to a new paper published by MSCI, which assessed funds labelled as Article 8 and 9 under the EU’s Sustainable Finance Disclosure Regulation (SFDR) on their degree of EU taxonomy-alignment, as well as their performance on, and disclosure of, select adverse sustainability impact indicators, and exposure to sustainable investments.
Of the 6,603 assessed Article 8 and 9 funds, only 126 reported a figure for EU taxonomy-aligned revenue, the report said, with 114 of them claiming zero aligned revenue. Further, an “overwhelming majority” of Article 8 (88%) and Article 9 (63%) funds stated ‘no intent’ vis-a-vis EU taxonomy alignment in their EU ESG template (EET) reporting.
The lack of taxonomy-alignment reporting is likely due to the “incomplete nature of the EU taxonomy and the high bar set to determine sustainable activities”, Rumi Mahmood, Head of ESG Fund Research at MSCI ESG Research and lead author of the report, told ESG Investor.
“The main challenge lies in the lack of underlying company reporting. If there is no data available from the underlying firms, fund managers don’t have any data they can aggregate, report to investors, or inform their allocation decisions,” he said.
SFDR Level 1, which went live in March 2021, asks asset managers to sort their EU-domiciled sustainable funds into Article 8 (environment and/or social characteristics) and 9 (environment and/or social objective). Level 2 came into force in January and requires asset managers to justify their fund categorisations through a series of environmental and social principal adverse impact (PAI) disclosures.
Asset managers are also required to indicate whether, and to what extent, any investments made by their Article 8 or 9 products are aligned with the technical screening criteria of the EU taxonomy, which outlines economic activities across environmental objectives that are considered sustainable and therefore suitable for investment via ESG-labelled fund solutions.
To make these disclosures, asset managers need information from portfolio companies, which is expected to be provided through the Corporate Sustainable Reporting Directive (CSRD), which will first apply to the largest companies from 2024.
There has been recent pushback against the latest iteration of reporting standards falling under CSRD, with investors arguing that the EU is rowing back on requiring certain key disclosure indicators to be reported on a mandatory basis, thus weakening the overall directive.
“Company reporting [on sustainability] is increasing, but the disclosure data required for the specific EU taxonomy-alignment criteria and eligibility is still not widely available,” said Mahmood.
Mind the gap
In the absence of reported data, MSCI analysed estimated EU taxonomy-aligned revenue to evaluate the portion of funds in MSCI’s coverage universe aligned to the taxonomy. Of 11,691 European-domiciled equity funds, 63% have a small degree of taxonomy-alignment. Funds with 20% taxonomy-aligned revenue accounted for just 2% of the assessed universe.
“There are still vast gaps [in corporate reporting], in particular from companies outside of Europe, presenting challenges in achieving taxonomy-aligned global portfolio diversification,” added Mahmood.
Across equity and fixed income funds, MSCI estimated that only 12 have a taxonomy alignment of over 60%, with ten having an investment focus on clean technologies and renewable energy, which the report noted suggests taxonomy alignment “may have come at the expense of sector diversification”.
“Investors are increasingly looking for sustainable fund solutions, but there are not necessarily a wide [or diversified] range of options for those looking to allocate by the new criteria,” said Mahmood, adding that there is a greater diversity of choice within Article 8 funds than 9.
“While this currently presents challenges for fund investors looking to achieve a diversified Article 9 portfolio, this is also an opportunity for fund providers to innovate and service the large gap that exists in the Article 9 market.”