Capturing the green opportunity

Money is one of the biggest levers the world can pull in terms of addressing climate change. “Funds play a key role in the transition to a green economy,” says Andrew Farmer, a director in KPMG Ireland’s sustainable futures practice.

“In the EU, funds are subject to sustainable finance disclosure regulation [SFDR]. One of the principal benefits of the regulation is the categorisation of funds in a uniform way.”

Funds are now typically classified as articles six, eight or nine. Article six is the default product category for plain vanilla funds that do not promote themselves as environmental, social or governance (ESG) funds.

Funds which fall within the scope of article eight are products that promote, among other characteristics, environmental or social elements, possibly both. They are known as ‘light green’ funds.

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Funds classified as article nine, or ‘dark green’ funds, pursue sustainable goals as an investment objective.

Fund managers categorising their funds as either articles eight or nine are subject to enhanced disclosure requirements to increase transparency and inform investors about the sustainability-related performance of their funds.

“From a regulatory perspective, the investment manager for the fund that would like to categorise their fund as ‘green’ must substantiate that the fund is either investing in only sustainable investments or promoting environmental or social objectives. As the fund industry continues to evolve this substantiation through SFDR disclosure, it is expected to have higher scrutiny by investors,” points out Farmer.

“As a result, those companies seeking investment from article eight or article nine funds will be required to increase their sustainability performance as a commercial imperative.”

According to a report from US company Morningstar, based on SFDR data collected from the prospectuses of 97.8 per cent of funds available for sale in the European Union, excluding money market funds, funds of funds and feeder funds, article-eight funds had market share of 55 per cent at the end of December, while article nine funds stood at 3.5 per cent.

The investment research and financial services firm identified outflows from both article eight and nine funds in the last quarter of 2023, however, which it attributed to macroenvironmental factors including high interest rates, inflation, fears of recession among some major world economies and geopolitical risks.

“Among other implications, this has led investors to favour government bonds, an area that has limited ESG products,” it pointed out.

It also suggested that some investors took a more cautious approach to ESG investing in 2023 in the wake of the underperformance of ESG and sustainable strategies in 2022.

Renewable energy companies, for example, were “particularly affected by soaring financing costs, materials inflation and supply-chain disruptions, among other issues,” it said. Additional factors weighing on investor demand for article eight and article nine products included “greenwashing concerns and the ever-evolving regulatory environment”.

Socially responsible investment has traditionally been the focus of charities and religious institutions but awareness of - and interest in - it is growing generally, says Eileen Rowsome, director of responsible investment at Davy Private Clients.

That includes entrepreneurs building their pension pots who wish to align their investment strategy with a sustainable world view, particularly where they have younger children, she adds.

Corporate clients, meanwhile, are increasingly looking to align their investment strategy with their corporate and social responsibility programmes.

A lack of standardisation across the investment industry led to confusion and the potential for greenwashing, she points out.

“It has been very difficult for retail and private clients to understand, firstly the investment arena and then the responsible and green investment arena. The regulation is aimed at doing that and the categorisation of funds is helpful for clients.”

Article nine products tend to be quite specific, she points out, with niche sector exposures such as clean water, or clean energy and contain a lot of industrial utilities. That is some distance from what, for most people, a broad-based equity fund should look like.

“As the regulation beds down we’re getting more clarity around it. But it does help people focus on what is purely a green, and what is considered a sustainable, investment,” she says.