EU fund classifications see limited upgrades despite regulatory clarifications

The European fund industry has witnessed only a modest number of sustainability upgrades this year, despite regulatory efforts to clarify sustainability criteria. In the wake of the European Commission’s clarification on sustainability determination in April 2023, expectations were high for a significant number of funds to transition from the Sustainable Finance Disclosure Regulation’s (SFDR) Article 8 to the more stringent Article 9. However, recent data indicates that only 35 funds made the upgrade, with just 15 doing so in the third quarter, according to Morningstar.

Morningstar highlighted that many managers of passive funds aligned with Paris benchmarks and climate transition benchmarks did not feel compelled to upgrade their Article 8 funds. This reluctance persists even though there is no commercial pressure deterring them. In fact, downgraded funds have seen inflows that are 40% higher than those into Article 9 products over the first nine months of 2023.

The hesitation among fund managers can be partly attributed to the ongoing changes in SFDR regulations. Analysts from Linklaters noted that the SFDR is still evolving, which makes reclassification a complex decision for fund managers. They are awaiting the final version of guidelines from the European Securities and Markets Authority on environmental, social, and corporate governance (ESG), as well as sustainability terms in fund names, before making any moves.

Refinitiv Lipper added another layer to this cautious approach by pointing out the absence of a standard definition for sustainable investment. With SFDR product classifications being a moving target due to potential changes at the EU level, fund managers are wary of prematurely upgrading their funds.

The European Commission released a consultation paper in September hinting at a comprehensive overhaul of SFDR, which could further influence fund classification decisions. Industry experts anticipate an increase in reclassifications once there is more regulatory stability and clarity.

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