EU green funds are experiencing "radical changes" as managers shy away from the strictest ESG label, and outflows follow, according to a Morningstar report released Thursday.
As the European Union's Sustainable Finance Disclosure Regulation approaches its second anniversary in March and managers implement tougher disclosure rules that came into effect this January, the balance of funds classified as the highest ESG designation under SFDR, Article 9, or "light green" Article 8 funds, changed dramatically, the Morningstar report said.
"Almost two years after SFDR came into force, the landscape of funds marketed as green in the EU is going through some radical changes," said Hortense Bioy, global director of sustainability research for Morningstar, in a news release on the report.
That was certainly the case for Article 9 funds in the final quarter of 2022, which saw their lowest inflows since SFDR began in 2021, at €5.1 billion ($5.5 billion). That inflow followed three previous quarters of outflows.
The low inflow "can be partly explained by the wave of funds that reclassified from Article 9 to Article 8 in the last three months of 2022," the report said.
Since last September, roughly 420 products changed SFDR status, with 40% of Article 9 category strategies downgraded to Article 8 — a shift of €175 billion in assets.
The market share of Article 9 passive funds shrunk to 5% as of Dec. 31, from 24% the previous quarter, following the reclassification of sizable index and ETF funds under EU climate benchmarks, Morningstar found.
It was better news for Article 8 funds. The strategies picked up €10.7 billion of net new money in the fourth quarter of 2022, having recorded three previous quarters of outflows.
That pushed the combined market share of Article 8 and 9 funds up to 55%, a 7.3% increase from the previous quarter that amounted to €4.6 trillion in assets, according to the report.
Morningstar expects the recent wave of Article 9 fund downgrades to continue, Ms. Bioy said, "raising questions about what will remain and how useful that category will be." Instead of looking at the Article 8 and Article 9 labels, investors will focus "on the level of exposure to sustainable investments, which cut across both classifications," she said.
