Funds and the State of European Sustainable Finance

Around 60% of the €12bn assets under management in Europe are invested in ESG funds or strategies with some sustainability focus, according to this MSCI report.

The report assesses how well these funds are aligned with three key regulations in the EU’s sustainability disclosures architecture: the green taxonomy, the sustainable finance disclosure regulation (SFDR), and the markets in financial instruments directive (MiFID II).

The results show a low level of EU taxonomy alignment and the authors – Rumi Mahmood, Sita Subramanian and Shuang Guo – argue that inadequate disclosure by firms is driving this misalignment.

The number of funds self-classifying as sustainable or ESG-linked rose rapidly in 2022. The authors say that 55% of assets under management now label themselves as article 8 (ESG-related) or article 9 (sustainability objectives) as per the SFDR. The regulation categorises financial product objectives and mandates certain disclosures based on the product’s stated aims.

The authors say this trend indicates a growing integration of sustainability into investment processes, but add there is “still a long way to go”.

The EU taxonomy provides a standardised framework for reporting the percentage of sustainable investments using consistent and comparable definitions.

Only 126 of the 13,419 European funds analysed officially disclosed a figure for EU taxonomy alignment, and 90% of those reported that none of their revenue was aligned. While the authors describe this level of reporting as “bleak”, they argue it is unsurprising given that 2023 is the first year non-financial companies have been required to disclose this information.

In the absence of adequate disclosure, the MSCI looked at estimated revenue and found that only 12 funds have over 60% of taxonomy-aligned revenue. This group was dominated by clean energy funds, which the authors say reveals a lack of diversification and a limited pool for sustainable investors.

The SFDR requires financial-market participants to disclose how they integrate sustainability, as well as the potential adverse impacts of their investments on sustainability, into their investment processes – as indicated by 14 principle adverse indicators (PAI).

The report’s results show EU funds are leading the pack globally, outperforming both the US and emerging markets in PAI disclosure. Disclosures regarding fossil fuel exposure and biodiversity performance were the least reported PAI across all markets.

Data from the EU disclosures showed that article 9 funds had the lowest carbon footprint, with over 60% distributed between the very low to moderate intensity categories. In contrast, around 60% of article 8 funds fell in the high to very high range.

Finally, the authors consider alignment with MiFid II. The directive sets out requirements for firms to integrate sustainability factors, including PAIs, into decision making. The amended regulation requires firms to inquire about the sustainability preferences of their clients, including whether they have a minimum percentage of sustainable investment.

The results show that around 30% have a minimum sustainable investment requirement of 10%, but less than 5% have a minimum of 25%. In contrast, 65% of Article 9 funds have a minimum requirement of 50%, which the authors attribute to the “do no significant harm” requirement for article 9 funds.