Fund Managers Brace for ESG Correction With $4 Trillion at Stake

Asset managers are trying to digest new regulatory proposals that have the potential to upend Europe’s biggest ESG fund category.

A plan by Europe’s markets watchdog, ESMA, to set quantifiable ESG and sustainable investing standards is forcing portfolio managers to rethink how they design and market an ESG fund class known as Article 8. Morningstar Inc. estimates that only 18% of Article 8 funds, which hold about $4 trillion of assets, currently meet the watchdog’s proposed threshold for sustainable investments.

There’s “a chill of realism,” blowing through the investment industry as managers digest the risks of getting environmental, social and governance designations wrong, said Matt Townsend, a partner at Allen & Overy in London. “This is starting to drive much greater caution in how products are being classified.”

It’s the latest in a wave of regulatory updates causing upheaval and triggering a sense of “mass frustration” among fund managers struggling to keep up, according to analysts at Jefferies International Ltd. There’s already been a cycle of downgrades from the EU’s top ESG class — Article 9— to Article 8, after the EU clarified its rules. Downgrading Article 8 funds, however, means forfeiting the right to market a product as ESG or sustainable.