44% of funds impacted by ESMA, full research and methodology

Clarity AI research finds that 44% of the funds using environmental and impact terms may need to change their name or divest assets.

The analysis shows that these funds are invested in assets that breach the Paris-aligned benchmark (PaB) exclusionary criteria. 

Asset managers will need to move fast: the guidelines were published on 14 May and will apply three months after their translation is published on ESMA’s website. Existing funds will then have six months to make the necessary adjustments.

 
 

In this first study, Clarity AI analyzed funds that specifically use environmental (including broad ESG and sustainable terms) and impact terms which are subject to applying the PaB exclusionary criteria related to exposure to certain sectors or revenue streams, such as fossil fuels, tobacco, and companies whose revenue comes from intense energy generation. 

The 44% of funds in breach of the PaB exclusions based on this first analysis will only increase when additional criteria is layered on top of this initial analysis. 

The new ESMA rule applies to any EU fund using an ESG or sustainability-related term in its name.  The rules vary depending on the term used, but broadly stipulate that any asset manager using a generic sustainability, environmental or impact term must ensure:

 
 
  • A minimum of 80% of assets are used to meet the environmental and/or social characteristics or sustainable investment objectives of the fund.
  • No exposure to assets that breach the PaB exclusions.

What does the name rule mean for funds with ESG terms?

Leveraging Clarity AI’s universe of more than 430,000 funds globally, Clarity AI found 3,256 funds domiciled in the EU that have environmental and impact related terms in their names in English. Of those 3,256 funds, the vast majority are Article 8 funds (74%) with Article 9 representing 19% and Article 6 just 7%.

Of the 3,000+ funds with environmental or impact related terms in their names, Clarity AI found nearly half (44%) contained investments in companies that breach the Paris Aligned Benchmark criteria. In fact, nearly a third of funds (28%) with environmental or impact related terms in their names have exposure to multiple companies in breach of the PaB exclusion criteria. 

 
 

In its final guidance, ESMA noted that Article 8 funds would likely be the most impacted by the rules. They also mentioned that Article 6 funds impacted by the guidelines may have to re-classify to Article 8 to ensure they can hit the 80% threshold for promoting environmental or sustainable characteristics or achieving sustainable investment objectives. 

In terms of breaches of the PaB exclusionary criteria, looking by article, we find nearly half (49%) of Article 8 funds with environmental or impact-related terms contain investments in companies with breaches, and around a third of Article 6 (36%) and Article 9 (29%) funds.

Research methodology

 
 

ESMA only provided a partial list of captured terms as part of its consultation or final rule.

Clarity AI therefore supplemented this list by undertaking a reverse lookup of EU funds in its universe containing terms that could be potentially captured. We considered only the top 25 most frequently used terms along with any explicitly mentioned by ESMA, before removing any social, governance and transition related terms. 

We took a narrow view of which terms could be considered environmental-related, to ensure our estimates remained conservative. We exclusively used English language terms in our sample, which covers the majority of funds in the EU.

 
 

Table 1: list of terms captured by the PaB exclusion criteria requirement

Examples provided in ESMA’s paperTerms identified via Clarity AI universe
Environment, Environmental, environmentallyClean
GreenCircular
ClimateWater
ESGCarbon
SRI (including “responsible”)Biodiversity
Impact, Impacting, ImpactfulPlanet
Sustainability, Sustainable, SustainabilityParis-aligned, PAB
 SDG

We then took all funds that included those terms in their names and ran them through Clarity AI’s Paris-aligned benchmark exclusion tool to determine which funds were exposed to companies in breach of the Paris-aligned benchmark exclusion criteria.

The limits imposed on fossil fuel-related activities are a key driver of these breaches. However, breaches occur across the board, including exposure to tobacco production and controversial weapons. These breaches are not isolated, as many funds were individually invested in multiple companies that violated the exclusion criteria. 

 
 

By exclusion we found that these funds were exposed to:

  • 1,077 funds were exposed to companies active in oil fuels production above the 10% revenue threshold
  • 875 funds were exposed to companies active in gas fuels production above the 50% revenue threshold
  • 574 funds were exposed to companies active in thermal coal production above the 1% threshold
  • 496 funds were exposed to companies directly involved in the production of controversial weapons 
  • 67 funds were exposed to companies generating electricity with an intensity above 100 g CO2 e/kWh
  • 60 funds were exposed to companies involved in tobacco production

Tom Willman, Regulatory Lead, Clarity AI comments:

“ While much of the commentary has focused on meeting the 80% threshold of assets to achieve sustainability characteristics or a sustainable investment objective, we believe that applying the exclusions from the Paris-aligned benchmark regulation may be a tough task for much of the industry. Funds will need to collect data in order to ensure that they are not exposed to any assets involved in tobacco, controversial weapons, or breaches of global norms, and that fossil fuel related activities are limited and below a certain threshold.

 
 

“The vast majority of the funds using related terms that are breaching the exclusion criteria are Article 8 funds. The limits imposed on fossil fuel-related activities are a key driver of these breaches. However, breaches occur across the board, including exposure to tobacco production and controversial weapons. These breaches are not isolated, as many funds were individually invested in multiple companies that violated the exclusion criteria.”

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