Shady business: The difference between light and dark green funds

Just as there are many different shades of green, so too are there different types of green investment funds. The EU Sustainable Finance Disclosure Regulation (SFDR) classifies investment funds under Articles 6, 8, and 9. Article 6 funds – sometimes known as “grey” funds – have no sustainable or responsible investing objectives whatsoever, while Article 8 and 9 funds can be described as light green and dark green respectively.

How important is this difference in hue? And just how green is green? University College Dublin’s Dr Fabiola Schneider is Sherpa to the European Commission’s Platform on Sustainable Finance. She explains that the SFDR requires asset managers to provide more information on the sustainability risks and impacts of their investment products sold in the EU by setting out transparency rules, which vary, based on self- classification into Article 6, 8 or 9 funds.

“Unlike Article 6, both Article 8 and 9 are considered sustainable yet they differ in level of ambition,” Schneider explains. “Article 9 funds have a sustainable investment objective and therefore are more ambitious, with stricter criteria, whereas Article 8 funds simply ‘promote’ environmental or social characteristics.”

Gayle Bowen is the managing partner of K&L Gates’ Dublin office. She says an Article 9 fund is an “easily identified offering”. “On the basis of a Q&A issued by the European Commission in 2021, their composition is quite prescribed, meaning that all of their holdings, alongside certain positions taken for specific purposes like hedging or liquidity, must qualify as sustainable investments and must satisfy the SFDR’s ‘do no significant harm test’,” she adds.

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Article 8 funds, on the other hand, can run the gamut in terms of sustainability, Bowen notes. The European Commission’s 2021 Q&A resulted in a significant downgrade of Article 9 funds to Article 8 funds, resulting in hundreds of Article 8 funds with a particularly high level of ESG ambition.

“But at the other end of the spectrum, there are Article 8 funds that, by virtue of the fact that they give some indication of promoting an environmental or social characteristic, fall within the scope of Article 8 when, in fact, their commitment to ESG might be minimal,” Bowen warns.

“Article 8 funds are often referred to as ‘light green’ funds but their classification alone really gives no indication as to their green credentials.”

Indeed, a recent survey carried out by MainStreet Partners, a subsidiary of AllFunds focused on ESG data, found that almost one in four (24 per cent) of funds categorised as Article 8 under the EU’s sustainability rules still carry a risk of greenwashing.

But beyond the shades of green and grey, these funds are surging. Schneider points out that, overall, assets in both Article 8 and Article 9 funds grew by 1.7 per cent in the final quarter of 2023, reaching a historic high of €5.2 trillion. “Collectively, these funds now make up nearly 60 per cent of the EU market,” she says.

High interest rates and a slowdown in some of the largest economies put on the pressure and led to significant changes in the fund industry during the fourth quarter of 2023, Schneider notes. And it is important to point out, she says, that while Article 8 funds constitute the majority of this 60 per cent market share, it is a highly diverse group.

“It can be viewed as something of a tilt towards Article 8 funds with higher per cent sustainable investment,” she explains.

According to Bowen, sustainable funds have been hugely popular since the SFDR took effect in March 2021 and, of the funds approved by the Central Bank of Ireland last year, around half were Article 8 or Article 9 funds.

“We have, however, seen a slight levelling off in the past six months,” she admits. “Demand amongst our clients remains high overall but we haven’t seen any increase in demand of late.”

This corresponds with the market, she notes, as Article 9 funds were reported to have suffered net outflows for the first time just last quarter, while outflows from Article 8 funds had started sometime earlier but appear to have accelerated of late.”

Demand for these products can vary by country and location of investors, Bowen adds.

“We see higher demand in the Nordics and some EU jurisdictions than from Asian, Swiss or US investors,” she says. This is despite the fact that strategies integrating ESG criteria have been seen to yield returns comparable to those of their conventional counterparts.

“As the SFDR beds in, there is a growing understanding in the industry and amongst our clients as to what it means to be an Article 9 fund or an Article 8 fund,” Bowen says. “Our advice and guidance is still required on the more technical aspects of the regulations but there is, by now, a baseline understanding of the core concepts by now.

“At investor level, and especially retail investor level, however, the SFDR and its product-level disclosures are not necessarily readily understood, as the disclosures can be technical.”

She says this is compounded by the fact that Articles 8 and 9, contrary to the European Commission’s intentions, have come to be used and recognised as product labels.

“This can be misleading in the context of Article 8 funds in particular, and this is something that the commission is now looking at.”

It’s worth noting that the SFDR is still evolving, with more changes likely, meaning the colour charts may vary once again, adds Schenider.

She points out that, having come into force in March 2021, a consultation on the SFDR’s functionality and future was only concluded by the European Commission in December 2023, meaning “significant amendments to the current regime” could yet be made.