A 'problem' lurking in ESG rules is outed by French watchdog

THE financial watchdog of France has issued a substantial criticism of European ESG regulations, warning that the current framework opens the door to greenwashing.

The concern centres on 2 main fund categories within European Union (EU) rules for environmental, social and governance investing, known as Article 8 and Article 9. The former has come to be dubbed "light green," because of the lower ESG bar it sets, while the latter, stricter category is referred to as "dark green." But according to the head of France's financial supervisory authority, Robert Ophele, the Article 8 and 9 tags do little to "guarantee sustainability."

"When it comes to the categorisation of products, we have indeed a problem due to the catch-all nature of the Article 8 product category, but which is also present for the Article 9," Ophele said in an interview. "It fuels greenwashing all the more."

Ophele, who is chairman of the Autorite des Marches Financiers, revealed deep concerns over the design of the EU's landmark ESG rulebook, the Sustainable Finance Disclosure Regulation. That criticism includes the extent to which national regulators have different interpretations of SFDR. He also suggested that some local watchdogs aren't policing ESG claims properly.

"SFDR doesn't provide for any harmonisation in the European fund landscape," Ophele said. "And it's fair to say that every national competent authority is implementing its own approach, if any."

Nor is there "any coordination" with the European Securities and Markets Authority, which hasn't been given adequate authority to oversee a consistent cross-border application of the rules, he said.

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"We are fragmenting the union and to some extent the passport which is at the core of the union for the fund industry," Ophele said. "It is inefficient and there is a tendency to push, to race to the bottom."

The list of criticisms feeds into an increasingly heated debate around the role ESG is playing in redirecting trillions of dollars of capital. The EU was ahead of other jurisdictions in enforcing its ESG rulebook for investors last year. But ESMA chair, Verena Ross, has since acknowledged that the framework is "incomplete and imperfect."

Meanwhile, the US Securities and Exchange Commission is sharpening its regulatory teeth around ESG. On May 25, the SEC announced it was taking its biggest anti-greenwashing step yet with a slew of restrictions aimed at ensuring ESG funds accurately describe their investments. SEC Chair Gary Gensler underlined his desire to "have consistent and comparable disclosures about asset managers' ESG strategies."

At the same time, scepticism around the value of ESG is being voiced more regularly and publicly, in part as fund managers adopt wildly different approaches to the investment model. Since SFDR's March 2021 implementation, there's been a surge in ESG products but little evidence they're contributing to a better planet. Earlier this year, Morningstar stripped ESG labels from funds representing more than US$1 trillion and has launched a new campaign to weed out sham ESG engagement strategies.

Ophele said the French regulator uses its own criteria for defining sustainability. For that reason, he doesn't tolerate the inclusion of fossil fuels in Article 9 funds.

For Article 8, "you could discuss what type of oil, what type of gas," he said. "But please be serious about that. Article 9, it is out of question, from my point of view. Article 8, perhaps under some conditions."

Exchange traded funds identifying as Article 9 under EU rules saw a 14 per cent surge in net inflows growth this year, even amid mounting losses, according to data compiled by Bloomberg.

Funds registered as Article 9 have been found to hold everything from Saudi Aramco, to Glencore Plc to Exxon Mobil Corp., according to data compiled by Bloomberg. Other financial regulators in the EU have started speaking out about the apparent dilution of the bloc's supposedly highest ESG designation. Sweden's FSA said in April it was reviewing Article 9 funds amid concerns of greenwashing.

Currently only a few jurisdictions, including France, set marketing requirements that financial products must meet to be sold as sustainable. The European watchdog that oversees EU regulators -- the Court of Auditors -- earlier this year characterised as "flawed" the bloc's supervision of its investment fund industry, including ESG. It warned minor changes won't be enough to create a "true single market."

In March, European authorities issued more guidelines, and the European Commission is considering minimum sustainability requirements for Article 8 funds.

"There is a clear understanding that the current situation isn't sustainable," said Ophele. BLOOMBERG