The greener, the better

Sustainable funds are reshaping the market and Ireland is driving to establish itself as a green hub. Increased regulatory certainty could see Ireland greening itself further, finds Piyasi Mitra.

A year ago, a small number of Extinction Rebellion protestors held a ‘die in’ – playing dead outside of the Irish Funds annual conference in Dublin. In the conference venue, a large number of the country’s fund professionals were meeting to further the aims of the Ireland funds industry, which include establishing Ireland as a ‘green’ funds hub.
In time for this year’s conference (to be held on 23rd May) new figures show how well Ireland and Luxembourg (the other large cross-border fund domicile with green ambitions) have been doing.

Research by law firm Maples Group found that 28% of funds domiciled in Ireland and Luxembourg were focused on sustainability. The firm’s second ‘SFDR Impact Analysis’ said this figure was similar across both countries.
The research said assets under management in sustainable funds domiciled in the two countries amounted to €5.5 trillion – a 19% increase on last year.
Despite this growth, Article 9 funds, characterised by a sustainable investment objective, represent 3% of Irish and Luxembourg funds currently. This is consistent with last year, and the lack of growth likely reflects the regulatory requirement since 2021 that Article 9 funds – or “dark green” funds – should consist mainly of sustainable investments, unlike “light green” Article 8 funds that promote ESG characteristics, or Article 6 funds that need not have any ESG characteristics at all.
However, the trend for Article 9 is evolving, according to Maples, with 7% of new funds launched in 2023 falling under this category. A substantial 22% of these are private equity funds, highlighting that Article 9 is rising in visibility in the private markets universe.
Ian Conlon, head of the Irish sustainable investing team at Maples Group, said: “SFDR is working as a catalyst for the transition to a low-carbon, more sustainable economy, by increasing the flow of capital towards sustainable activities and enhancing the transparency and accountability of sustainability disclosures.”

“SFDR is working as a catalyst for the transition to a low-carbon, more sustainable economy, by increasing the flow of capital towards sustainable activities and enhancing the transparency and accountability of sustainability disclosures.”

“Differing values”
Instances of firms misrepresenting the sustainability of their funds have led to caution around the launch of Article 9 funds. Some asset managers downgraded their funds from Article 9 to Article 8 – the self-classification system under the EU Sustainable Finance Disclosure Regulation (SFDR).
Hortense Bioy, global director of sustainability research at Morningstar, suggests funds will be less worried about greenwashing once incoming regulation increases the reliability of data that fund managers need in order to prove their credentials. A major piece of reporting is the ‘principal adverse impact’ (PAI) statements, as well as showing that funds are aligned with the EU green taxonomy.
“Asset managers use a variety of data, including reported and estimated data from third-party data providers as well as internal data – mainly from analyst research and engagement. Different metrics have varying levels of clarity in computation. Asset managers, employing diverse data sources and methodologies will inevitably yield differing values in their PAI statements,” says Bioy.

“Different metrics have varying levels of clarity in computation, inevitably yielding differing values in their PAI statements.”

“Estimated data is a key factor contributing to the vast differences in PAI reporting seen at product-level and entity-level, too,” she adds.
With the implementation of the Corporate Sustainability Reporting Directive, which will apply this year, and an increase in sustainability reporting across the market, Bioy envisages data-availability limitations should diminish. The directive requires in-scope companies to make disclosures on the risks and opportunities arising from social and environmental issues, and on the impact of their business on people and the environment.
Meanwhile, Morningstar Q1 2024 data shows that although Article 8 funds saw a €14 billion inflow (rebounding from three-quarters of outflows), Article 9 funds faced outflows of nearly €4 billion for the second straight quarter and that Article 6 funds – those with no explicit sustainability characteristics – attracted €43 billion in net subscriptions, marking a substantial rise compared to previous quarters of modest inflows.
Over the last five quarters, Article 6 funds consistently outperformed Article 8 and Article 9 funds in terms of flow performance.

“Recent performance challenges of dark green funds – especially those exposed to renewable energy (MSCI Global Alternative Energy Index down -36% from Jan 2023 to end April 2024) – have also taken some shine off green funds.”

According to Luc Simoncini, head of product specialist team at Irish funds manager Mediolanum International Funds Ltd, the timeline of many pieces of the EU sustainable finance framework played a part in the small percentage of Article 9 funds. The SFDR rolled out before CSRD could provide investee data, cites Simoncini, and as a result, 72% of Article 9 funds report 0% alignment with EU Taxonomy.
However, recent performance challenges of dark green funds – especially those exposed to renewable energy (MSCI Global Alternative Energy Index down -36% from Jan 2023 to end April 2024) – have also taken “some shine off green funds”, he points out.
Rooting for green funds’ investment opportunities driven by principles rather than trends, Simoncini underscores the importance of “right-sizing”. According to him: “Thematic green funds should be used as a satellite allocation – a small part of a broader portfolio. Removing emotions from the equation is also key, so we’ve developed an investors’ programme based on dollar cost averaging, helping clients take advantage of periods of market weakness and stay invested instead of retreating.”

Disclosure vs labelling
Gabriel Wilson-Otto, head of sustainable investment strategy at investment manager Fidelity International, considers the SFDR “a step change in fund-level sustainability disclosures”. However, he adds it’s important to remember the SFDR was intended as a disclosure regime – not a product labelling regime.
“Managers seeking to have funds disclosed under Article 8 or Article 9 need to interpret the requirements and establish their internal frameworks and controls.”
Article 9 funds are required to invest all assets (excluding cash and hedging) in sustainable investments, explains Wilson-Otto. However, each manager must define their universe of sustainable investments, leading to a broad spectrum of approaches and results.
“The lack of consistency between Article 8 or Article 9 funds means that due diligence of delegated managers is required to ensure the integrity and comparability of an external manager’s approach with the standards adopted by the delegating entity. The European Securities and Markets Authority’s proposed naming rules have the potential to help harmonise exclusions for funds with ESG or sustainability words in the fund name, but do not provide a product labelling regime,” Wilson-Otto adds.
Aiming to help navigate such challenges, Fidelity International has established a “sustainable product architecture” that provides a set of requirements for funds to disclosure under Article 8 or Article 9. The in-house tool gauges the alignment of an entity’s economic activities with the UN Sustainable Development Goals by measuring the percentage of use of proceeds for labelled bonds.
How do insiders view the balance between ESG demand and regulatory hurdles for funds aiming to classify themselves as Article 9 compliance under EU rules? As Lisa Kealy, Emeia ETF leader at wealth manager EY, sees it, a key challenge is that the SFDR has often been employed as a labelling system, with the ESG-related attributes of investment funds tagged as either Article 6, Article 8 or Article 9 funds.
“As a result, investors frequently express their preferences for investment products by referencing the product categorisation outlined in the SFDR. With increased focus on ESG claims and reputational risk concerns, this has seen many Article 9 funds re-categorised to Article 8.”
As part of an EU consultation, a categorisation system for financial products will potentially be introduced, Kealy shares, under which product categories should be clear, have targeted outcomes and measurable criteria. “To help balance between investor demand, competition and regulatory challenges, firms can introduce external party assurance that can challenge the completeness and robustness of SFDR frameworks and disclosures, providing comfort and trust to investors,” suggests Kealy.

Challenges of the delegated model
Given the reliance on delegate investment managers for SFDR compliance among third-party AIFMs and Ucits management companies managing a substantial portion of Irish-domiciled funds, steps should be taken to address the regulatory gaps identified in the model and ensure effective ESG integration.
Third-party management companies (ManCos), like Carne or Waystone, generally operate under a delegated model, whereby the day-to-day management is delegated to an underlying investment manager who has arranged the set-up of the fund, while the ManCo addresses the regulatory requirements.
According to Kealy, given the nature of disclosures required under SFDR, responsibility for this information is generally delegated to the underlying investment manager. “Depending on size and location, they may have differing local expectations and requirements in preparing the disclosures. This may result in gaps in the SFDR requirements.”
To address this, the ManCo could take steps to introduce external third-party assurance to challenge the completeness and robustness of SFDR frameworks and disclosures, providing additional comfort to both the ManCo and the directors of the fund that regulatory disclosures are at the level expected, suggests Kealy. “The ManCo should also conduct impact assessments, gap analyses and develop implementation plans with the underlying investment managers to align with the evolving SFDR provisions.”

“We expect pressure from the real estate industry to lead to changes to Article 9 requirements, a move that we find would be welcomed by many of our clients.”

In a similar tone, Conor Durkin, funds partner at law firm Pinsent Masons, stresses the importance of ensuring that the delegated portfolio manager has a robust ESG or sustainable appraisal framework integrated into its investment processes.
“This has required fund managers to interrogate the sustainable investment appraisal policies of delegate investment managers and ensure that such policies are aligned to policies of the fund manager and consistent with the fund’s offering documents,” says Durkin.

“Too challenging”

Dutch supervisor Authority for the Financial Markets (AFM) has backed proposals to abolish the Article 8 and 9 categories for investment funds under the SFDR. The body published its position on the future of the controversial EU regulation last year, created to force fund providers to be more transparent about how they approach sustainability in their products.
AFM has been among those to have highlighted the misuse of SFDR by the investment industry. Providers can categorise their sustainability-focused products as ‘Article 8’ – having social or environmental characteristics – or ‘Article 9’ – pursuing social or environmental objectives.
Along with ditching the Article 8 and Article 9 categories, the supervisor wants the EU to “introduce sustainable product labels that investors can understand, such as ‘transition’, ‘sustainable’ and ‘sustainable impact’”.
AFM wants each of its three labels to include “specific minimum quality and disclosure requirements”. Funds that don’t identify as sustainable should also be forced to disclose a “limited number of sustainability indicators” focused on capturing negative impacts, it said.
Jillian Giberson, senior policy analyst at sustainability consultancy Longevity Partners, says he’s seen many clients adopt a more conservative approach aligned with SFDR Article 8 rather than Article 9. According to Giberson, this is because many find the requirements for Article 9 alignment “too challenging”.
For instance, due to the stringency of the Article 9 classification, real estate funds have struggled as most assets must be considered “sustainable” upon acquisition to qualify. For many value-add funds and other investment strategies, these constraints render Article 9 classification “unattainable”, explains Giberson.
There is hope. Following the 2023 consultation on the SFDR, the classification system is likely to be adjusted to fit industries like real estate.
In the consultation, the Commission suggested that the Article 8 and 9 classifications may be scrapped entirely, a move that has been supported by industry actors including the European Association for Investors in Non-Listed Real Estate Vehicles.
“Regardless of whether the existing classification system remains, we expect pressure from the real estate industry to lead to changes to Article 9 requirements, a move that we find would be welcomed by many of our clients.”
Non-EU delegate investment managers, who may not be well-versed in SFDR, have had to adjust their sustainable assessment policies. According to Durkin, this often involves adopting additional sustainable screening tools and engaging in more thorough negotiations regarding contractual terms governing sustainable investment appraisal by the delegate investment manager.
“We have seen Article 9 sustainable funds with different strategies that have been successfully deployed include funds investing in low carbon issuers, cross-sectorial funds investing in sustainable leaders and more recently sustainable bond funds. More niche article 9 strategies we observed include forestry regeneration funds and battery storage funds,” shares Durkin.
Navigating Articles 8 and 9 guidelines offers both opportunities and challenges in the fast-changing realm of sustainable investment funds. Despite greenwashing concerns, insiders are optimistic about how EU sustainability initiatives can foster growth and transparency.

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