The European Securities and Markets Authority (ESMA) asked credit rating agencies to improve their referencing of ESG factors, as increasing funds flow into so-called green investments.
During the first half of 2021, volumes of assets in EU sustainable funds increased by more than 20 percent and totalled a record EUR 1.5 trillion, according to Reuters. The dramatic growth rates imposed additional pressure on rating agencies willing to meet soaring investor interest in ESG factors and sustainable investments.
The EU wants to increase the flow of funds to sustainable investments and help its economy meet net-zero emissions targets. However, regulators are increasingly concerned about over-inflating sustainable credentials to attract investments and ‘greenwashing’ on the part of companies.
Last week, the ESMA announced a “high level of divergence” among raters in their ESG disclosures “even for rated entities that are highly exposed to ESG factors.” The statement points to the urgent need for credit rating agencies to improve their referencing of ESG factors.
The EU’s securities watchdog earlier announced that it will review the market for ESG ratings on businesses.
The number of investment funds sold or marketed as using sustainable metrics is rising. At the end of last year, the EU Investment funds marketed as sustainable under the Sustainable Finance Disclosure Regulation (SFDR) managed EUR 4.05 trillion in assets, according to Morningstar. The volume constitutes a more than twofold increase from EUR 2 trillion in April 2021, shortly after the EU watchdog introduced the new regulations.
The growth is down to investors willing to put more cash into products that follow the ESG agenda, and managers reclassifying more of their existing products as sustainability-aligned.
The SFDR classification is about disclosing relevant ESG information but it doesn’t constitute an ESG label.
Under the new EU regulations, managers can classify their funds under different articles. For instance, Article 8 means the funds promote “among other characteristics, environmental or social characteristics, or a combination of those characteristics,” while Article 9 means they are entirely focused on sustainable objectives.
According to Morningstar, in the last quarter of 2021, Article 8 and 9 funds captured 64 percent of all EU fund inflows, up from 41 percent in the second quarter. Furthermore, the company’s analysis covered 91 percent of the funds domiciled in the EU. It claimed that since SFDR’s introduction, almost half of all new fund launches have been under Articles 8 and 9.
Although the EU’s new regime has been described as a significant boost to transparency, some critics argue that it has allowed managers to lose definitions and take different approaches to classify their funds.
Morningstar claimed that some funds classifying themselves as sustainable had made no changes to their portfolio.