Recent probes into the disclosure of sustainable investments have been a red flag for many investment managers, highlighting the need for clearer and more homogenous regulations in this area.

One of the difficulties the industry faces when addressing key ESG topics is the fact that the regulatory environment is becoming stricter, whereas data collection remains heterogeneous and subjective, leaving the field wide open to interpretation and optimization.

The recent Sustainable Finance Disclosure Regulation (SFDR) is a good example. Since March 2021, fund managers have had to classify their funds into one of three categories, corresponding to Articles 6, 8 or 9 of the SFDR. Basically, a fund classified as Article 6 does not integrate any kind of sustainability into the investment process, a fund classified as Article 8 integrates ESG criteria but this is not the main objective of the fund, and a fund classified as Article 9 is driven by a sustainable investment objective. 

Clearly, the difference between Articles 8 and 9 may be subject to interpretation. Some have concluded that, while an Article 8 classification can be based on a passive quantitative filter, an Article 9 classification requires active engagement with the investee companies. Does this pose an obstacle to achieving Article 9 status? Not really. Some managers have simply classified their funds as Article 9 by enriching their investment processes with ESG-related questionaries sent out to the investee companies, complemented by various active dialogue initiatives (usually a very vague concept). 

With the decisions on classification being made by the asset management company, the first part of 2021 saw fund managers rushing to classify their funds under Article 8 or 9. According to Novethic and a study performed by Morningstar, 34% of European assets have already been classified under these two Articles. However, according to a survey by E&Y, only 37% of asset managers actually use non-financial data on a regular basis. When asset managers opt for a high classification, it creates an incentive for their competitors to do the same, even in cases where they would normally have chosen a lower one. Rather than being an objective risk metric, the SFDR classification runs the risk of becoming a subjective marketing tool. Clearly, more orthodoxy needs to be reintroduced into ESG disclosure.

The general expectation is that regulators will jump in to make the classification more homogeneous, but will all regulators behave in the same way? Will the French AMF take the same view as the Lichtenstein FMA, the Irish CBI or the Luxembourg CSFF? Their work should start in early 2022, and it will be very interesting to see what happens.

While these existing disclosure requirements await fine-tuning, a new set of requirements is already on its way: the Taxonomy. The Taxonomy is an EU system for the classification of environmentally sustainable economic activities, with six environmental objectives established under Regulation 2020/852. To be recognized as Taxonomy-aligned, an economic activity must first be established as eligible for Taxonomy application, after which it must contribute to one or more of the six objectives. On top of this, it must do no significant harm to any of the other objectives, and comply with technical screening criteria as well as minimum social safeguards.

Exposure to both Taxonomy-eligible and Taxonomy-non-eligible economic activities will need to be disclosed before 2024. This will mean, among other things, quantifying the revenue breakdown of any company in a portfolio under the Taxonomy eligibility criteria.

The lack of data accuracy in this area is significant. With regulatory pressure mounting, there is a significant risk that some investors and investment managers will adopt short cuts and weak methodologies, while others seek to be extremely prudent and rigorous. The heterogeneity of disclosure will thus be complex to deal with for investors.

The need for more sustainable finance is obvious, but the burden represented by increasing regulation could become counterproductive. Regulators are setting rules while the necessary homogeneity and quality of data is not fully in place. The current global situation certainly requires strong actions from public bodies, but if the complexity created by regulation is ignored, the aim of genuinely improving the sustainability of investments may not be fully achieved.

Fabrice Rossary

CIO SCOR Investment Partners

^{This article is an opinion article and does not constitute investment advice or recommendations. Neither the author nor SCOR Investment Partners assume any liability, direct or indirect, that may result from the use of information contained in this opinion article.}