How to promote sustainable investment through SFDR art. 9 funds?

The European Union's (EU) Sustainable Finance Plan, approved in 2019, explicitly included the need to provide transparency and channel funds towards sustainable investments, both of which were addressed by the Sustainable Finance Disclosure Regulation (SFDR), approved that same year. Indeed, the SFDR comes into force in 2021 as the first legislative initiative on transparency of sustainability information for investors.

The SFDR establishes disclosure requirements based on the "degree of sustainability" of the financial product. It is therefore conceived as a reporting and transparency initiative. However, in the absence of an instrument to categorise or catalogue sustainable investment products, the market uses the SFDR as a financial product classification tool. Products are categorised as "Article 8 funds" or "Article 9 funds" according to their greater or lesser contribution to sustainability. The European Commission, aware of this and other limitations, is considering a revision of the regulation only two years after its entry into force. We are currently awaiting this amendment.

Meanwhile, sustainable investment in the EU is robust and reaches 56% of assets under management (hereafter AUM) in the EU, unlike what is happening on the other side of the Atlantic (where it is contaminated by ideological and political issues). However, this trend is not reflected in the volume of "dark green" funds, which barely represents 3% of AUM (1% in Spain). Why is this the case? During the discussion held at the Aula How to promote sustainable investment through SFDR art. 9 funds, organised by Gabeiras in collaboration with Triodos and UPF-BSM, some explanations were put forward:

• The main one has to do with the uncertainty caused by the discretion or absence in the qualification criteria and the definition of "sustainable". This vagueness and lack of clarity in identifying what is a sustainable investment objective creates uncertainty for financial actors. As a result, fund managers prefer to "downgrade" their rating to avoid supervisory pressure, reputational risk and accusations of greenwashing the market.

In relation to the latter, we would like to draw attention to the problem that a lowering of the tone and visibility of the marketing of financial products could pose... Greenhushingcould lead to less demand for sustainable financial products, less visibility and prescription in the financial agenda and, in short, go against the ultimate goal of these initiatives, which is to strengthen the financing of sustainable initiatives.

• Another explanation as to why "dark green" investment is not keeping pace with the growth of overall sustainable investment may have to do with the compliance burden that Article 6 products do not have. The SFDR establishes meaningful reporting requirements for "green" financial products, but "non-green" ones are not subject to any transparency or disclosure criteria in this regard. This makes it comparatively easier to manage and market them. In other words, the more sustainable a financial product is, the higher the requirements in terms of transparency, disclosure and reporting. In the interests of transparency, would not the management and marketing of sustainable financial products be discouraged or made more expensive?
• A third reason may have to do with retail customer demand for this type of product. The absence of a classification or categorisation of sustainable financial products makes it difficult for the retail investor to understand this type of investment. Most retail customers may not be sufficiently knowledgeable to demand the inclusion of ESG criteria in their investments. And if criteria are not in place to clearly identify what is and is not sustainable, the retail customer may feel insecure and confused. In this sense, the alignment of SFDR with green MiFID is key.

In addition, the financial manager himself may discourage retail customer demand for green investments, as a consequence of the fears and reluctance mentioned in the previous paragraphs. Here, the incentive to market green financial products is decisive and must also come internally from the financial institutions themselves.

Having established some of the reasons that may explain the weakness of the market for "dark green" financial products, we can go on to analyse some of the other characteristics observed in this type of financial products.

Firstly, we observe a very strong bias towards environmental aspects to the detriment of social or governance aspects. One explanation could come from the greater development of environmental taxonomy as opposed to social taxonomy. It is also due to the very nature of environmental criteria, which are more objective and quantifiable, as opposed to social criteria, which are more qualitative and refer to processes, and to the urgency of the climate challenge and the risks it generates. This weakness, due to the absence of a more developed definition of the social taxonomy, could be compensated for by the inclusion of social issues in the principle of DNSH(do not significant harm) or in the social safeguards provided for in the EU's own environmental taxonomy. The reinforcement of these two parameters foreseen in the environmental taxonomy could contribute to strengthening the social perspective of investments despite not yet having a specific taxonomy.

Secondly, there is a strong concentration of dark green funds' investment in a few stocks. At European level, according to Social Investor, there are 5 stocks present in more than 100 funds, holding more than 5% of their market capitalisation. They are Vestas, Xyem, Amercian Water, Darling Ingredients and SolarEdge. In Spain, EDP Renovaveis is among the 8 equity funds analysed, Schneider Electric in 7 and Trimble, Vestas and Johnson Matthey in 6, with different weights. This concentration could lead to an inflation in the price of these stocks, which could damage the profitability of the investments.

The study "Challenges of Dark Green Sustainable Investment" elaborates on some other characteristics of this type of investment, such as exposure (albeit marginal) to controversial sectors and complex investment instruments. Questions such as the effect of the SFDR review on the market, the analysis of retail demand, the investment strategies used (beyond best-in-class as the currently dominant strategy) or a comparison at European level remain to be addressed in a future report.