Shortly after the dust had settled in Sharm El Sheikh and COP27, and some 9,000 kilometres west of the Sinai desert, Montreal was hosting COP15, the United Nations Biodiversity Conference. It was the first time the conference had been held since 2018. It aims to implement the protocols of the Convention on Biological Diversity (CBD) and the post-2020 biodiversity framework.
While biodiversity stakeholders demand increased capital flows into nature, the reality of regulatory changes on the other side of the Atlantic could deter managers from launching dark-green products in the future.
The EU’s Sustainable Finance Disclosure Regulation (SFDR) will become mandatory on January 1, 2023. Confusion around what SFDR counts as a sustainable investment and how to prove it could disincentivize managers from launching ambitious products for biodiversity gains (or at least no net loss).
Better safe than sorry
In reaction, the fund universe has seen a wave of voluntary declassifications from the world’s biggest asset management houses, including Blackrock, Amundi, Deutsche Bank AM, and BNP Paribas AM. Many of their Article 9 funds – which must include 100% of sustainable investments as defined by Article 2.17 of the SFDR – are being downgraded to Article 8, or funds that merely promote environmental, social and governance characteristics.
To date, the trend affects over $100 billion of assets. Amundi’s own reclassification represents €45 billion of holdings, and BlackRock $26 billion.
What has prompted this last-minute change? Investors say the latest round of guidance on how to interpret the EU regulations lacks clarity and forces them to downgrade as a precaution, to avoid any future allegations of greenwashing and punitive measures from the regulator.
More specifically, they are unsure about how to prove that all their investments are indeed sustainable.
A recent report by global data provider FE FundInfo states that of the 6,000 funds submitted for Article 9 classification as of August 2022, only 79 have 100% as the minimum investment in sustainable investments.
Third-party data
As always with issues around fund labelling and greenwashing, it comes down to what data is available. Hundreds of funds are impacted by regulatory severity, but the implications are even more acute for biodiversity funds, where accurate corporate reporting is still scarce.
As it stands, the European regulator pushes asset managers to rely on robust third-party data to demonstrate the sustainability of their investments. In its biodiversity data assessment report, the Carbon Disclosure Project (CDP) found that some 70% of the 7,700 companies that responded do not assess the impact of their value chain on biodiversity.
If managers start excluding companies that don’t currently report on precise biodiversity metrics such as mean species abundance, they may be left with an investment universe that is too small to operate in.
If managers start excluding companies that don’t currently report on precise biodiversity metrics, they may be left with an investment universe that is too small to operate in
European listed multinational companies typically score very highly with third-party data providers, and some fund managers fear that this assessment method would force them to exclude small-cap companies and emerging markets, players that may be contributing greatly to reducing net biodiversity loss but are simply not disclosing it properly.
Most impact fund managers welcome higher standards because they see that greenwashing scandals could lead to a loss of faith in the industry and stall capital allocations. But there is a risk that the stringent regulatory environment will have the unintended consequence of homogenising the biodiversity fund universe.
In addition, the Article 8 category features a much wider range of products with more or less rigorous stock selection processes, which defeats the purpose of multiple categories that give consumers clear choices.
Biodiversity thematic funds are still scarce, but these dark-green investment vehicles were becoming more frequent as the asset management industry becomes well versed on identifying nature-positive stocks. If the classification does not help these high-impact products stand out from their ESG-compliant peers, there is a disincentive for that corner of the industry to keep improving.
Mandatory disclosure regulations are essential to tackle greenwashing. But unless the guidance is crystal clear on how investors can quantify sustainability, we’ll be left with no impact funds and more confused consumers.
