Europe has led the way in ‘green’ investment product classification.
But other jurisdictions shouldn’t follow the European Union (EU) down the same naming path, according to Daniel Aguet, Scientific Beta deputy chief.
Aguet said the multiple EU directives on sustainable investment taxonomy while paved with good intentions have ended in confusion at best.
“The main conclusion is that the good intentions of regulators have had unintended consequences, resulting in less effective outcomes for investors,” he said.
For example, the ground-breaking EU Sustainable Finance Disclosure Regulation (SFDR) introduced in 2019 faced a major overhaul just four years later in the wake of a reclassification crisis.
A tweak to the SFDR framework in 2021 putting a tighter definition on ‘sustainable assets’ saw hundreds of funds stripped of their previous green labels.
“The problem was that fund managers were using SFDR – which was intended as a classification system – for marketing purposes,” Aguet said.
And he said because the original definitions were so vague, managers were able to badge their products at the high-end of ‘sustainable’, or ‘Article 9’ in the EU parlance.
When regulators moved to clarify the wording in 2021, the “wave of reclassifications” rocked the foundations of SFDR.
“Instead of clarity, the rule change created huge instability for investors,” Aguet said.
Subsequently, regulators in the region have called for a new sustainable product regime based on the “more precise EU taxonomy” introduced in 2023, he told the Responsible Investment Association of Australasia (RIAA) NZ conference last week.
The new European Securities and Markets Authority (ESMA) guidelines were published to “ensure that investors are protected against unsubstantiated or exaggerated sustainability claims in fund names, and to provide asset managers with clear and measurable criteria to assess their ability to use ESG or sustainability-related terms in fund names”, Aguet said in his presentation.
However, the ESMA framework is also “problematic”, he said, featuring a mix of both vagueness and rigidity.
“The new guidelines impose that funds using ESG terms must exclude companies ‘related to controversial weapons’ or ‘in violation of the United Nations Global Compact principles’, without any further details on definitions,” Aguet told the RIAA crowd.
In practice, that might see, for instance, funds exclude between 0.2 per cent to 2.3 per cent of the global investment universe depending on which definition of ‘controversial weapons’ managers chose.
Furthermore, the EU guide would require funds claiming low-carbon status to exclude fossil fuel companies that collectively “also generate about half of renewable electricity”, Aguet said.
“It is possible to build a fund with a low-carbon footprint without excluding any companies,” he said. “We think the EU guideline goes too far in limiting the possibilities for investors.”
Aguet also said investors should take care with corporate carbon emission data given the wide variety in metrics – especially with so-called ‘Scope 3’ information.
While he said there was a reasonable correlation between different researchers on the easier-to-gauge Scope 1 and 2 emissions, the more ephemeral Scope 3 data is “notoriously hard to estimate”.
For instance, there is barely any overlap on Scope 3 measures in respective research carried out by Institutional Shareholder Services (ISS) and Trucost.
“Measuring emissions is important and the direction of research is good,” Aguet said. “But funds have to be careful about what emissions claims they make given the inconsistency in the data.”
Scientific Beta, a Singapore Stock Exchange subsidiary, specialises in factor-based, ESG and climate-related indices.