Reading the SFDR Article 8 and 9 categorisations

Effective March 10, 2021, the Sustainable Finance Disclosure Regulation (SFDR) has become the gold standard for sustainable and responsible investment.

Part of the wider European Union (EU) regulatory framework to promote environmental, social and governance (ESG) considerations in financial markets, the SFDR sets out key rules for financial market participants. SFDR classifies financial products into three categories - Article 6 (No ESG focus), Article 8 (Promoting ESG),and Article 9 (Sustainable funds). This classification assists investors in making informed decisions.

There are two parts to this regulation that we'll be looking at in more detail: Article 8 and Article 9.

They define the disclosure requirements and criteria for classifying financial products according to ESG factors. Understanding these articles is essential for asset managers, financial advisors and investors.

‍

Quick facts and figures

In 2022, despite the economic crisis and the war in Ukraine, Article 9 products recorded inflows of 12.6 billion euros, double those of the second quarter.

According to MorningStar research, assets in Article 8 and Article 9 funds rose by almost3% in the third quarter to €4.3 trillion. By comparison, assets in Article 6funds (no ESG targets - do not mention sustainable characteristics in their communication to investors) fell by 9.6%.

The market share of Article 8 and Article 9 funds continued to grow, reaching 53.5% at the end of September 2022.

380 products changed status in the last quarter of 2022. The vast majority moved from Article 6 to Article 8, but 41 were downgraded from Article 9 to Article 8.

In France, the top ten asset management companies with the most Article 9 funds are Amundi and its subsidiaries (39 funds), Axa (35 funds) and Natixis and its subsidiaries (21 funds). With 37 billion euros, Pictet has the largest Article 9 assets under management in France, ahead of BNP Paribas and Amundi, with 19 billion euros each.

But apart from these key figures, how do you differentiate between Article 8 funds and Article 9 funds?

‍
What is Article 8?

Under Article 8, companies are required to demonstrate that their investment products favour environmental and/or social characteristics. Article 8 funds promote sustainable characteristics by taking ESG criteria into account as part of the investment process, but without pursuing a sustainable investment objective.

This means that investment strategies and underlying assets may have ESG objectives but not be subject to binding sustainability criteria. Funds must indicate how they integrate ESG factors into their investment decisions. This regulatory approach builds confidence in ESG investments and encourages companies to adopt sustainable practices, ultimately benefiting both investors and the environment.

However, the implementation of Article 8 is demanding. Financial institutions must ensure that their investment processes are transparent through reporting, so that investors can make informed decisions. In other words, funds must disclose their PAI (Principal Adverse Impacts), i.e. a set of indicators detailed in the technical review criteria report associated with the SFDR. This involves knowing whether a fund supports environmental or social qualities, and whether the companies benefiting from the fund's investments adhere to good governance procedures.

‍

What is Article 9? 

Article 9 takes sustainability a step further. It concerns funds for which sustainability is the primary objective. This category is not about evaluating a process but a fund itself.

The objectives of Article 9 are clear: to channel investment into projects that make a significant contribution to environmental and social objectives. The financial products covered by this article must focus on reducing the carbon footprint, promoting social equality and sustainable development.

It requires rigorous assessment, constant monitoring and transparency that goes beyond Article 8. Financial institutions must ensure that their investments are aligned with sustainability objectives, leaving no room for greenwashing. Financial market participants must comply with the Regulatory Technical Standards (RTS) to provide reports on the potential sustainability impacts of financial products. The deadline for financial market participants to submit this report is 30 June 2024. The European Commission is putting these reports out to consultation by a restricted public.

‍

Which appellation to choose: Article 8 or Article 9

The choice between belonging to Article 8 or Article 9 depends on the sustainability and investment objectives of each fund.

If sustainable development is what you want to be attractive about, Article 9 maybe a better match for your objectives. Your investments are explicitly geared towards companies that meet these objectives. Article 9 funds invest for the long term because of their focus on sustainability.

Article 8 offers a balance between sustainability considerations and financial returns, making it suitable for funds that want to minimise risk while supporting sustainability.

In summary, both categories offer the opportunity for funds to align their investments, to varying degrees, with their sustainability preferences. Understanding the distinction between these categories can help you make informed investment decisions. With ScaleX, we help investors, funds and our corporate clients to collect reliable data, including sustainability data.

It is important to note that regulators continue to issue new guidelines and statements regarding this information and its interpretation, as understanding of the industry is continually evolving.

How classification works?

It's important to understand that the SFDR is designed to prevent greenwashing by requiring players who claim a sustainable approach for their financial products to publish information enabling investors to carry out their own analysis of the sustainable dimension of these products. Classification is determined by the asset management companies themselves.

The classification of a fund in the article 8 category, for example, is not a label or guarantee of quality. Indeed, the definitions proposed by the regulations leave considerable room for interpretation by financial players.

‍

The SFDR requires all financial products, regardless of their stated sustainability ambitions, to publish information on how environmental, social and governance (ESG) risks are integrated, as well as their potential impact on the value of the investment. This transparency enables investors to make informed decisions, promotes sustainable growth and encourages asset management companies to adopt sustainable principles and practices. At ScaleX, we share the SFDR's commitment to transparency. That's why we rely on private data provided by companies to help our clients manage their portfolios. Our ESG module, at company and portfolio level, enables reliable reporting and informed decision-making.