Since its implementation in 2021, the EU Sustainable Finance Disclosure Regulation (SFDR) has successfully redirected flows from non-ESG funds to ESG ones. In Luxembourg, over 50 percent of Ucits funds are now classified as either an Article 8 or 9 fund, marking a significant surge in sustainability-focused investments.
On the surface, this success seems unsurprising, as ESG investing is purported to offer higher returns to investors compared to non-ESG alternatives, all while contributing to environmental and societal well-being. However, whether investors have genuinely reaped these benefits remains unclear.
In reality, it appears that everyone is benefiting from SFDR except the investors themselves.
Asset managers
Investors' evident appetite for ESG funds has led fund sponsors to adapt their product ranges, incorporating Article 8 and 9 funds to meet the demand. The allure of increasing assets under management, and in some cases charging higher fees, has proven irresistible.
Regrettably, there is scant evidence that ESG funds can consistently outperform or match the returns of non-ESG funds. Furthermore, due to a high correlation of assets held by both types of funds, investors might obtain equivalent exposure at a lower cost.
In the long term, funds delivering suboptimal returns may witness capital outflows.
Data providers
In the realm of ESG, data has become a valuable commodity, with providers like MSCI and Sustainalytics earning over a billion euros by selling ESG data to asset managers. SFDR's strict reporting requirements on fund sponsors have made this data indispensable.
Armed with this data, providers have developed ESG scores for funds and individual assets, selling them to investors to aid in investment assessments and capital allocation. Unfortunately, this data is often expensive and, in some instances, unreliable for ESG purposes.
SFDR's design necessitates hard-to-collect and curate data, leading data providers to resort to proxies and models, potentially overcharging and misleading investors.
Bureaucrats
Implementing SFDR has consumed significant resources, both in time and material, over several years, involving bureaucrats, lawyers, and politicians. If SFDR successfully guides private capital to ESG projects, the time and effort invested will be deemed well spent. Conversely, if SFDR proves to be ineffective, taxpayer money might have been squandered.
In conclusion, while SFDR appears to have benefited the ESG ecosystem and encouraged capital flows into ESG funds, in reality this success is nuanced by various issues faced by investors, such as unreliable data and uncertain returns on investment.
SFDR might provide benefits, but not necessarily to the investors, who are, ultimately, the most crucial stakeholders.
Gregory Kennedy is a columnist for Investment Officer Luxembourg. His columns appear every other week. He also works as a business development manager at Finsoft Luxembourg.
Further reading on Investment Officer Luxembourg:
- With or without ESG, investor returns still paramount in US
- FCA warns asset managers on inadequate ESG practices
- Contours of SFDR 2.0 are gradually emerging
