The principal adverse impact (PAI) on sustainability factors considered by more ESG funds than any others is their underlying companies’ exposure to controversial weapons, closely followed by their involvement in violation of the United Nations Global Compact (UNGC) principles.
The UNGC is a non-binding pact to encourage businesses worldwide to adopt sustainable and socially responsible policies, and to report on their implementation.
An analysis of over 78,000 European ESG Templates (EETs) collected from nearly 200 fund groups by fund data and technology company FE fundinfo showed that, at the end of July 2022, almost 88% of Article 8 funds (those that promote environmental or social characteristics, known as “light green”) and over 96% of Article 9 funds (those with sustainable investment as an objective, so called “dark green”) consider the proportion of investments involved in controversial weapons.
33,000 (42%) of the EETs received by FE fundinfo are for Article 8 funds, just over 5,000 (6.5%) are for Article 9 funds, and the other 40,000 received to date are either for Article 6 (non-ESG) funds or for products that are out of scope of the EU’s Sustainable Finance Disclosure Regulation (SFDR).
86% of Article 8 funds and 94% of Article 9 funds consider the principal adverse impact of the share of companies involved in the violation of UNGC principles. While slightly more (almost 96%) Article 9 funds consider the adverse impacts of companies active in the fossil fuel sector, this PAI is considered by fewer (68%) Article 8 funds.
Matthias Breier, ESG Product Manager at FE fundinfo said: “As Article 9 funds are expected to invest entirely in sustainable investments, it is no surprise that a very high number consider these PAIs. In addition, over 80% of Article 9 funds consider the greenhouse gas emissions, energy production from non-renewable sources and board gender diversity of their underlying companies.”
Since 2 August, anyone in the EU offering investment advice or discretionary management services must consider any sustainability preferences their clients may have as part of their suitability assessment, under changes to MiFID II and the Insurance Distribution Directive (IDD). The EET was created by the industry group FinDatEx to enable fund and product providers to provide information on the ESG credentials of their products.
The changes to MiFID II and the IDD state that meeting a client’s sustainability preferences requires a fund to have an agreed minimum proportion invested in environmentally sustainable investments as defined by either the Taxonomy Regulation or the SFDR, or it must consider principal adverse impacts on sustainability factors.
As well as the PAIs, providers can use the EET to report any screening criteria adopted by their funds. Of the EETs collected by FE fundinfo, nearly a fifth (19%) exclude at least one criterion, the most common of which are unconventional weapons (17.7%), coal (15.4%) and tobacco (14.7%).
Matthias Breier added: “Funds can only claim an exclusion policy if it is in the prospectus, so we are not talking here about the investment choice of the manager. The European regulations specify what meeting investors’ sustainability preferences entails, but there will also be many clients who want to invest in funds that take an ethical stance and avoid particular criteria.”