The European Securities and Markets Authority (ESMA) announced last month that investment funds using ESG (Environmental, Social, and Governance) labels or similar terms will be required to allocate at least 80% of their assets to genuine ESG objectives. Additionally, these funds will be prohibited from investing in specific assets, including major oil and gas producers.
This mandate is expected to have significant effects, particularly for fund managers who are heavily invested in US stocks, according to a Morningstar Inc. analysis.
“The US market could experience the most substantial impact in terms of stock market value,” Morningstar reported. They estimate that around 42% of the potential stock divestments prompted by ESMA’s new rules will affect the US, based on market value. France follows at 17%, with China at 12%.
Alternatively, some fund managers may opt to avoid the effort of portfolio redesign and instead choose to rebrand their products.
Arthur Carabia, Director of ESG Policy Research at Morningstar Sustainalytics, shared on LinkedIn that many funds are expected to remove “ESG” and related terms from their names. They might adopt terms that align with less stringent requirements under the EU’s new regulations, such as “transition,” he suggested.
Morningstar has identified approximately 4,300 EU funds with ESG or sustainability-related names that might be impacted by ESMA’s new guidelines. Given that these funds are barred from investing in companies on the EU’s exclusion list as per the Paris-aligned benchmark rules, Morningstar estimates over 1,600 funds will need to divest stocks totaling up to $40 billion to retain their current names.
The sectors most vulnerable to divestment due to ESMA’s new regulations include energy, industrial sectors like railroads and defense, and basic materials, according to Morningstar. US companies such as Exxon Mobil Corp., Schlumberger NV, Wells Fargo & Co., and Chevron Corp. are identified as at risk of being divested by EU-based ESG funds.
EU member state regulators are required to integrate these guidelines into their market supervision or explain why they do not intend to comply. Hortense Bioy, Head of Sustainable Investing Research at Morningstar Sustainalytics, does not anticipate a definitive list of ESG or sustainability terms from regulators.
“There will be some leeway for interpretation,” she mentioned in an interview.
These naming regulations are part of the EU’s broader efforts to address gaps in its key Sustainable Finance Disclosure Regulation (SFDR). The financial industry will soon learn whether nearly five years of work on SFDR will need to be rethought.
The EU’s banking, insurance, and market regulators stated this week that they are finalizing a joint opinion on SFDR, including proposed amendments. Their findings will heavily influence how the European Commission and lawmakers will address SFDR issues post-elections, when a new parliament is in place.
In the interim, asset managers will focus on meeting naming requirements to comply with regulators. Due to frequent accusations of greenwashing, asset managers “will want to tread carefully,” Bioy advised.
VBNGtv News Roundup
– ESMA Regulation**: New ESMA rules restricting how freely asset managers can use the ESG label in Europe are likely to cause a significant industry shake-up, as per Morningstar Sustainalytics.
– ECB Fines**: The European Central Bank is set to fine several banks for not adequately addressing climate-related risks in their business operations.
– AI Oversight**: The US Treasury Department is collecting more information on financial firms’ use of AI, assessing potential risks and opportunities.
– CBAM Concerns**: A study indicates that the EU’s Carbon Border Adjustment Mechanism (CBAM), intended to protect local industries during the green transition, may have unintended negative consequences.
– Tariffs Impact**: EU tariffs on Chinese electric vehicles could cost China approximately $4 billion in trade with the EU, according to a new analysis.
– Bond Restrictions**: Credit Agricole SA has stopped underwriting traditional bonds for oil and gas companies amid tighter regulations.
– Greenwashing**: Europe’s market watchdog emphasized the need to better equip regulators to tackle greenwashing in the ESG market.
– Commercial Real Estate Risk**: Major banks are implementing new criteria for loans to commercial real estate, which will affect the sector’s access to financing.
– Barclays Warning**: Analysts at Barclays Plc warn that more stocks will be excluded from ESG funds under new EU rules.
– UK Anti-Greenwashing Rules**: The UK has introduced stringent anti-greenwashing regulations for banks and asset managers.
– Divestment Move**: Europe’s largest pension fund, Stichting Pensioenfonds ABP, has divested from all liquid assets in oil, gas, and coal, worth approximately €10 billion ($10.8 billion).
– ISSB Standards**: Companies globally will soon be subject to unified requirements for reporting the impact of climate change and environmental factors.
– Greenwashing Alert**: Europe’s fund industry has been accused of frequently promoting their ESG credentials without proper documentation, raising fresh greenwashing concerns.
– FDIC Resignation**: Martin Gruenberg will step down as head of the FDIC after findings of a toxic work environment led to calls for his removal amidst a political scandal.
