$40bn divestment threat looms over EU ESG funds under new guidelines


A new report by Morningstar reveals that nearly two-thirds of funds in the EU labelled with sustainable or ESG-related terms may need to divest assets or alter their names to comply with new anti-greenwashing regulations.

According to ESG Today, the report estimates that stock divestments could reach as much as $40bn if all affected funds choose to retain their current names.

The report comes in response to the European Securities and Markets Authority’s (ESMA) recent release of its finalised guidelines for the use of ESG and sustainability-related terms in investment fund names. These guidelines aim to mitigate the risk of greenwashing, a concern that has grown alongside the increasing use of sustainability-related terminology in fund names across Europe in recent years.

Under the new guidelines, funds that utilise terms such as ESG, sustainability, impact, or specific environmental terms like “green,” “environmental,” or “climate,” must meet specific investment thresholds. Notably, at least 80% of their assets must align with the fund’s stated sustainability characteristics. Furthermore, these funds must adhere to exclusion criteria based on Paris Aligned Benchmarks (PABs), which disqualify investments in companies with substantial revenue from oil, coal, or gas production, emissions-intensive energy generation, and those involved in controversial industries like weapons and tobacco.

A notable addition to the guidelines is the “transition” category, which includes funds labelled with terms suggesting improvement or progress, such as “improving,” “progress,” “evolution,” and “transformation.” These funds must also meet the 80% investment threshold but follow the less stringent Climate Transition Benchmarks (CTBs) exclusions, allowing investment in companies deriving some revenue from fossil fuels.

Morningstar’s research involved an extensive search of its Morningstar Direct database, identifying nearly 4,300 mutual funds and ETFs potentially affected by the new guidelines. Of these, approximately 2,500 had stock-holding data available. Among this subset, over 1,600 funds held at least one company that violated PAB or CTB exclusion rules, with around 30% having at least five such holdings.

The report indicates that if these funds were to divest the non-compliant stocks to maintain their names, divestments could total up to $40bn. Morningstar predicts that many funds will likely drop ESG-related terms from their names or reposition themselves as “transition” funds to align with the less stringent CTB exclusions.

“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 thousands of ESG funds changing names and/or adjusting their portfolios to comply with the new rules,” Hortense Bioy, Head of Sustainable Investing Research, Morningstar Sustainalytics, said.

The Morningstar findings align with a recent analysis by sustainability technology platform Clarity AI, which found that over 40% of ESG-labelled funds might need to change names due to the new ESMA guidelines. Morningstar’s analysis also highlighted that if the threshold for sustainable funds to invest meaningfully in sustainable investments were set at 30%, nearly half of these funds would need to increase allocations to sustainable investments or rebrand.

The sectors most likely to be affected by divestments include energy, industrials, and basic materials, with significant holdings in companies such as TotalEnergies, Shell, and Tencent Holdings being at risk due to violations of the UN Global Compact principles on human rights.

ESMA’s new guidelines will take effect three months after their publication in all EU languages on the ESMA website, with existing funds required to comply within six months from that date. Morningstar estimates that the guidelines could impact existing funds by March 2025.

“It may be tempting to assume that the big reshuffle ahead means many ESG funds have been greenwashing. But up until now, there were no minimum standards. The guidelines have the benefit of raising the bar for ESG products and will hopefully bring greater clarity to investors on what they are investing in,” Bioy added.

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