The new year heralded both a new update to the criteria of the EU green taxonomy and the much-anticipated Regulatory Technical Standards (RTS) of the Sustainable Finance Disclosure Regulation (SFDR).
The legislation for both is broadly what was laid out when the bills were signed earlier in the year, however the challenge for many financial institutions, particularly regional ones, has not been questions over what the rules and disclosure requirements will look like, but investor appetite for them.
“The European Banking Authority has been bombarding banks with notes and warnings to promote the taxonomy and SFDR so they could start complying from day one,” says Pedro Capitão Barbosa from Lisbon-based law firm Morais Leitão. “But the investor appetite for green products is just not there yet, so the new SFDR RTS and taxonomy regulations are unlikely to get much pick-up in the short term.”
Notably, the CBI stated that its own supervisory approach would evolve over time
A further difficulty is data collection, he says.
“If, for example, a private equity fund wanted to offer an Article 8 or 9 fund investing in small and medium-sized enterprises, they would have a lot more difficulty to get that data than a fund based somewhere like Sweden because the awareness is just not there.”
Appetite for compliance varies widely across the region.
“Taxonomy compliance is not a hot topic here,” says Katerina Kraeva, partner at Wolf Theiss in Sofia. “Asset managers know they need to comply with the new regulations, but at the same time there aren’t many products in the market that are eligible for the taxonomy.”
The rules also present a challenge for local regulators that have the responsibility of enforcing rules from the European Securities and Markets Authority (Esma) and the European Central Bank in member states.
“I don’t think local regulators will be aggressive on environmental, social and governance regulations or that they’ll look at banks’ work in this area with heavy scrutiny,” says Kraeva. “Again, it will take time until this becomes an issue in practice rather than just a topic for discussion.”
This is not universally true. In 2021, the Central Bank of Ireland (CBI) issued a ‘Dear CEO’ letter setting out their expectations of financial services firms in relation to climate and ESG issues more broadly, explains Andrea Lennon, head of fund services for Ireland at Crestbridge.
There are five key areas of focus that are aligned with the European direction of travel: governance, risk management framework, scenario analysis, strategy and business-model risk and disclosures.
“Notably, the CBI stated that its own supervisory approach would evolve over time,” she adds.
And far from lagging behind, some French banks have expressed frustration that the regulatory updates are actually coming too slowly.
Unlabelled
For those asset managers that do have appetite for taxonomy-aligned and SFDR Article 8 or 9 products, more challenges await. A lack of regulatory certainty has created the risk that funds that claim Article 8 or 9 stamps could be accused of greenwashing, prompting a new trend – greenbleaching.
“There was a general rush to Article 8 and 9 products when it was a self-certification process,” Lennon says, discussing the situation in Ireland. “Subsequent guidance from Esma and the Central Bank of Ireland has slowed down the number of Article 9 funds being registered and has seen some Article 9 funds being reclassified as Article 8 and to a lesser extent, some Article 8 funds being declassified.”
The problem is that while many people view the SFDR as a labelling system for funds, legally it is not, according to Andreas Stepnitzka, deputy director of regulatory policy at the European Fund and Asset Management Association (Efama).
“This distinction is important," he says, "as it means that funds cannot choose whether they are going for a label but rather have to do these disclosures which put them into those Articles 6, 8, or 9 categories.”
Many definitions, such as sustainable finance, are not defined in the RTS or the SFDR. This prompts uncertainty and encourages asset managers to take the legally safe option of downgrading or declassifying the funds.
Asset managers have not been the only ones to eschew EU labels. In the third quarter of last year, Nordea issued an innovative $400 million bond to fund its sustainability-linked financing activity. The bank made it clear that while the product would be ESG-positive, it would not fit any of the new EU-wide labels.
Dampened investment
For other financial institutions, the taxonomy-compliant label is more important.
Isabelle Laurent, head of funding at the European Bank for Reconstruction and Development (EBRD), has told Euromoney about her concerns if their current SFDR exemption is not extended in 2024.
As it stands, asset managers do not have to include investments in sovereigns and supranationals when disclosing the proportion of different funds that are taxonomy-aligned.
Despite the impactful environmental projects they undertake, most of the EBRD’s investments are not expected to be taxonomy-compliant due to different market standards outside the EU and a lack of available data and problems translating it to projects.
The concern is that green and dark green funds may not buy EBRD’s bonds if the exemption were discontinued.
This attitude to the taxonomy creates problems for the bank, making it harder to finance emerging markets projects.
“There’s this view that anything that says it’s green or promotes ESG but isn’t taxonomy compliant is just greenwashing,” says Laurent. “And that’s really problematic.”
EU policymakers may now begin to reconsider their next steps, particularly for the new voluntary EU Ecolabel to tackle greenwashing in retail investments, which could set apart products with more than 50% taxonomy-compliant assets.
Research published at the end of the year by Esma shows that less than 1% of funds would meet the minimum requirements set out by the proposed label.
The regulator considered 3,000 ESG Ucits (Undertakings for the Collective Investment in Transferable Securities) funds with Article 8 or 9 labels and found only 16 products met the 50% threshold.
Such a low percentage may prompt the regulator to reconsider its position, but the pipeline of new rules will continue.
