ESMA’s ESG fund naming guidelines may force over 1,600 funds to rebrand or divest up to $40bn worth of stocks, according to Morningstar Sustainalytics.
Last month, the European Securities and Markets Authority (ESMA) published its final guidelines on fund names using ESG or sustainability-related terms. Funds will either need to comply with new portfolio requirements or change their names.
In a new report, Morningstar Sustainalytics assesses the potential impact of the ESMA guidelines on the EU ESG fund landscape.
Hortense Bioy, Head of Sustainable Investing Research, Morningstar Sustainalytics said: "While it is impossible to predict the full impact of these guidelines, we expect their implications to be significant. They have the potential to completely reshape the ESG fund landscape in Europe, with potentially thousands of ESG funds changing names and/or adjusting their portfolios to comply with the new rules.
"It may be tempting to assume that the big reshuffle ahead means many ESG funds may have been greenwashing. But the reality is that up until now, there were no standards, and it's a complex area. The guidelines have the benefit of setting minimum standards for ESG products and will hopefully bring greater clarity to investors on what they are investing in.”
Morningstar identified around 4,300 EU funds with ESG or sustainability-related terms in their names that may fall in scope of the new guidelines.
Of 2,500 funds with stock holding data, we found that more than 1,600 are exposed to at least one stock potentially in breach of the PAB and CTB exclusion rules. This represents a significant number (two thirds) of funds that may need to consider to either divest from the stocks or rebrand.
If all these funds were to keep their names, it could lead to stock divestments worth up to $40bn.
The sectors most affected by the potential divestments include energy, industrials (e.g. railroads, defence), and basic materials.
The most impacted countries would be the US, France, and China, in terms of market value, but China, US, and India in terms of number of companies. The most affected stocks would include TotalEnergies, Tencent Holdings, Ecolab, and Shell.
When interpreting the PAB/CTB exclusion rules and sourcing data, managers will decide how far they want to go in companies' value chains and assess the related investment implications.
Because of the stringent nature of the PAB exclusions, Morningstar said it expects many funds to drop "ESG" and related terms from their names, while some will reposition as transition funds, to which the less constraining CTB exclusions apply, provided they can demonstrate a clear and measurable transition path.
At best, only 56% of funds with the specific term "sustainable" in their names would be able to keep the term if the minimum threshold for a "meaningful" allocation to sustainable investments is set at 30%. The remaining 44% of funds would need to increase their allocation to sustainable investments, tweak their sustainable investment methodology, or rebrand.
