Dmitry_Rukhlenko on Envato
The European Commission headquarters in Brussels, Belgium
The EU Commission is set to implement significant changes to the regulation of sustainable financial products, specifically targeting the current Article 8 and Article 9 funds under the Sustainable Finance Disclosure Regulation (SFDR). These reforms aim to enhance clarity and comparability among sustainable investments, which will have notable implications for investors in German real estate, both foreign and domestic.
As part of the EU's broader goal of achieving climate neutrality by 2050, the EU Action Plan includes key reforms such as the Taxonomy Regulation and the SFDR. The Taxonomy Regulation, effective since July 2020, provides a classification system to guide investors on which economic activities are environmentally sustainable. It establishes six environmental objectives, including climate change mitigation, adaptation, and ecosystem protection.
The SFDR, in force since March 2021, defines standards for green financial products and requires fund companies to disclose their sustainability objectives and the risks they consider in their investment processes. This includes mandatory indicators like greenhouse gas emissions and gender diversity on boards, aimed at preventing greenwashing.
Abolishing Article-8 and Article-9 funds
The EU Commission plans to abolish the existing Article 8 and Article 9 funds, replacing them with two new categories: "sustainable" and "transition".
Sustainable: Products must meet sustainability criteria from the outset.
Transition: Products are given time to meet sustainability targets.
ESG expert Lisa Watermann from GSK Stockmann explains that these changes will address the vagueness of the current categories, which have evolved from transparency requirements into labels that confuse investors. "Think of it as cleaning out the attic," she says. "You can't just label everything 'valuable' and 'old stuff' without causing some confusion." The new categories aim for greater clarity, with stricter criteria expected for funds to qualify as sustainable.
Fund managers will need to reassess their portfolios to comply with the new standards. This involves determining whether each fund fits into the "sustainable" or "transition" category and ensuring the entire portfolio meets the required criteria. Watermann anticipates that most real estate funds will struggle to meet the new criteria initially, as stricter conditions will apply compared to the current Article 8 standards.
Funds emphasizing social components will also need to uphold ecological characteristics. Existing funds are unlikely to be grandfathered in, as this would counteract the goals of transparency and comparability.
Implications for investors
For investors in German real estate, these changes mean a more rigorous approach to sustainability in investment options. The new categories will provide greater transparency and comparability among sustainable investments, although the transition period may temporarily reduce the number of qualifying products. "It's like switching to a new diet," quips Watermann. "There may be fewer choices at first, but the quality of what's on offer should improve."
In the long term, higher standards will lead to more reliable sustainability claims. The reforms are also expected to advance the social taxonomy, which currently lacks measurable assessment criteria. The European supervisory authorities have highlighted the need for social assessment criteria in their recommendations, addressing a gap in the current system.
Recent data from Morningstar Direct shows that Article 8 funds have recorded net inflows in the first four months of 2024, while Article 9 funds have experienced outflows. Article 8 funds raised €16.85 billion year-to-date, despite a negative April. Conversely, Article 9 funds saw net redemptions totaling €7.13 billion over the same period.
Stricter rules for fund names
In a further move, the European Securities and Markets Authority (ESMA) is also introducing stricter rules for funds using ESG or sustainability-related terms in their names. These funds must comply with new portfolio requirements or change their names. This guideline is expected to reshape the ESG fund landscape in Europe significantly.
Hortense Bioy, Head of Sustainable Investing Research at Morningstar Sustainalytics, notes, "The guideline has the benefit of setting minimum standards for ESG products and hopefully giving investors more clarity about what they are investing in. It's like a much-needed spring cleaning for the industry."
As these reforms are implemented, both fund managers and investors in German real estate will need to navigate the evolving landscape of sustainable finance, adapting to higher standards and more rigorous criteria. The whole emphasis on greater transparency and comprehensive sustainability assessments is designed to foster a more reliable market for sustainable investments, and hopefully much more clarity.
