A major shift is taking place around the funding of environmental, social and corporate governance (ESG) initiatives in Europe, as ESG investors signal that they want to be part of a more tangible impact.
New data has suggested that $30 billion in investor capital has been withdrawn from a cohort of European funds in the three months from April-June 2022, according to figures from Chicago-based investment firm Morningstar Inc.
What these funds have in common is that the EU’s investment rulebook considers them all to be within a single category of ESG-related initiatives, and now, enthusiasm for this category is fading.
Meanwhile, another has picked up a smaller amount of extra funding. In other words, investors are changing their priorities.
What is the EU’s ‘ESG investing rulebook’
It is officially called the “regulation on the disclosure of information related to environmental, social and governance criteria in the financial sector”, or SFDR, and it was passed by the European Parliament and Council in 2019.
SFDR is essentially a tool that shines a much greater spotlight on ESG investing, with the goal of preventing “greenwashing” or any other practice that paints an investment as sustainable when it isn’t.
SFDR splits investments into three main categories based on how much the associated strategy aligns with ESG values. These categories are covered by Articles 6, 8 and 9 of SFDR regulation.
- Article 6 covers funds which have no connection to ESG.
- Article 8 covers funds which promote the environmental or social components of ESG.
- Article 9 covers funds which specifically target sustainable investments, meaning the good/service at the endpoint of the investment is directly connected to ESG.
Article 8 has been seen as a mid-point on this scale – albeit not always in a positive way. For its perceived vagueness since coming into force, it has gained the nickname of the “light green” option.
Where are ESG funds going?
$30 billion has been withdrawn from funds connected to Article 8 within a quarter of 2022, Morningstar Inc’s data has said. At the same time, $6 billion has been sent into initiatives connected to Article 9.
Why the shift?
Such an outward flow of cash from Article 8 follows frequent criticism over its weak wording and disagreements over what it actually means.
The notion of “supporting” ESG values through investing has been vague enough that investors and funds still have varying opinions about what it involves, and because of that, there has been no adoption of a universal benchmark, or a set of standards for cross-comparison purposes.
As a result, many investors with a previous interest in Article 8 are now suspecting that it might not yield the sustainable results they had hoped for. This is backed up by other Morningstar figures, which show that around target very low levels of exposure to sustainable investment – between 0 and 10%.
What does this mean for ESG?
At first glance, it represents a teething issue for the SFDR and the EU’s efforts to promote more sustainable investments.
For investors, board, and company managers, it suggests that the appetite for demonstrable ESG progress has grown firmer. Investors are less and less attracted to vaguer notions of promotion and are growing more nervous about these kinds of funds as a result.
Has the drop in support for Article 8 been replaced by an equal uptake in support for Article 9? No, not yet. But it is something to keep a close eye on in the next 12-18 months.