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Europe’s flagship green investing framework has failed to increase investment in “sustainable” funds or encourage fund managers to construct more environmentally friendly portfolios, new research has found.
Academics from Stanford, Harvard and Amsterdam universities and London Business School found the EU legislation, introduced in 2021 to encourage sustainable investment, had not meaningfully improved funds’ green credentials in terms of carbon emissions or on other measures, nor had it boosted fund flows to green funds.
The findings are likely to strengthen the view of some critics that the investment industry is unable to significantly help combat climate change and is instead engaging in so-called greenwashing to present itself as more environmentally friendly than it really is.
“Our results suggest that the SFDR [regulation] was ineffective in influencing the behaviour of investors and mutual funds,” the academics said in the paper, published by the National Bureau of Economic Research.
“The introduction of the SFDR did not result in higher flows into either light or dark green mutual funds,” they added, referring to different classifications of sustainable funds, “nor did it materially alter the sustainability of their portfolios”.
The findings come as the EU seeks to overhaul its five-year-old Sustainable Finance Disclosure Regulation in order to address what it calls “shortcomings” in the legislation, provide “simpler and more usable information for investors” and reduce disclosure requirements and compliance costs for the funds industry.
The SFDR was introduced in order to police the fund industry’s use of labels such as ESG (environmental, social and governance) and stamp out greenwashing, where funds’ adoption of green labels is little more than a marketing gimmick. At the time there were hopes among some in Europe that the framework might become a global standard.
Under the legislation, each existing fund was given a classification based on how green it was. Article 9 is for vehicles that “significantly contribute to sustainable objectives” and invest 100 per cent of assets in companies deemed sustainable by the asset manager; Article 8 funds “promote social and environmental characteristics”; and Article 6 funds do not incorporate any measure of sustainability.
As of November last year, there were 12,000 Article 8 funds in operation and 1,000 Article 9 funds, according to data from Morningstar, alongside 12,000 Article 6 funds. Article 8 funds held €6.5tn of assets, while there was €317bn in Article 9 vehicles and €4.8tn in Article 6 ones.
The researchers used three separate indicators to measure the impact of funds’ adoption of Article 8 and 9 status on their sustainability: portfolio-weighted carbon emissions; environmental ratings constructed by data group LSEG; and carbon risk scores calculated by Morningstar. The paper found no meaningful change in any of these metrics following the introduction of SFDR.
“Across all specifications, the estimated effects are either statistically absent or economically small,” they said.
Some in the industry say that the categorisation of funds is too confusing for many investors, meaning that money has not flowed to greener funds as intended.
The paper found that investors “struggle to understand SFDR disclosures”, adding that providing more detailed explanations of categories could have increased the impact of the SFDR regime.
“I think awareness of the Article categories, especially among retail investors, is close to zero,” said Andrew Clare, professor of asset management at London’s Bayes Business School, adding that he was not surprised by the paper’s findings.
“It does suggest that the industry/regulator should do more to make people aware of the meaning of the categories, otherwise it’s just another massive regulatory tick-box exercise. And heaven knows there are already enough of them,” he added.
Estimates vary for the cost to funds of complying with SFDR, although the European Commission has estimated that the industry faced one-off implementation costs of €500mn and annual recurring costs of €246mn.
“The amount of time, money and effort that the industry has put into this is disproportionate when you look at the results,” said Hortense Bioy, global director of sustainability research at Morningstar.
“It has cost a lot. [There has been] regulatory fatigue [and] it hasn’t worked because it’s too complex. All this new information was just confusing everyone,” she added.