Application of the EU Ecolabel to retail financial products : is the market ready ?

1. Background : the EU Ecolabel as a guarantee for consumers

Whereas the EU Ecolabel is currently available for specific sectors of goods and services, it has been discussed, since 2018, to extend such EU Ecolabel to financial products that are available to retail.

In March 2021, the Joint Research Center (JRC) of the European Commission developed and published a list of criteria to be met by financial products seeking the Ecolabel.

The specific criteria proposed by the JRC relate to :

(i) the alignment of the investments with the EU Taxonomy ;
(ii) the exclusion, with defined thresholds, of activities that are deemed to be detrimental or opposed to environmental objectives ;
(iii) the application of minimum social and governance safeguards ;
(i) the use of a clear and non-misleading engagement policy followed to pursue environmental objectives ;
(ii) specific measures taken to enhance investor impact (e.g. reporting mechanism) ;
(iii) periodic information for retail investors and on the EU Ecolabel.

The establishment of the Ecolabel for financial products has been developed in parallel to a constant increase of interest for ESG and sustainable investments.

2. The application of the Ecolabel to financial products

a. A growing need

The European market is witnessing an increase of interest for sustainable, ESG and impact investing, notably linked to the development of sustainable disclosure regulations.

With the quick and inadvertent use of the Sustainable Finance Disclosure Regulation (Regulation (EU) 2019/2088 or so-called SFDR), setting out transparency requirements, the market today differentiate as a classification tool between “light green funds” (or funds disclosing under Article 8 SFDR), “dark green funds” (or funds disclosing under Article 9 SFDR) and “grey” funds (funds disclosing under Article 6 SFDR only). Such classification facilitates the channeling of financial flow towards sustainable investments.

As a result, sustainable funds almost reached two trillion euros at the end of 2021 in Europe, with about half of the newly established funds in Europe disclosing either under Article 8 or Article 9 SFDR.

This – nearly – overwhelming enthusiasm for sustainable investment is unfortunately supported by the increasing risk of misleading claims and the misuse of SFDR provisions. The significant number of financial products that are claimed as “green” puts the investors’ trust in sustainable finance to the test. The intervention of the EU and national regulators becomes inevitable to address the increasing risk of “greenwashing”.

In line with the current work of the ESAs on greenwashing through various consultations, the creation of the Ecolabel for retail financial products becomes particularly relevant and would, in particular, (i) facilitate the comparison by investors between products claimed as sustainable, (ii) provide guarantee on the greenness of the product, (iii) increase transparency on the market and the credibility of the sustainable finance framework.

Recently, ESMA conducted a study in order to calibrate the criteria of such Ecolabel. The report of the analysis was published on 21 December 2022.

b. Eligibility of existing financial products to the Ecolabel

The Ecolabel for financial products, as developed by the JRC, sets a mix of quantitative and qualitative criteria as strict eligibility requirements.

To assess whether the proposed Ecolabel criteria draws the line between ensuring feasibility criteria, while keeping the credibility of the label, ESMA conducted a study on a sample of 3,041 sustainability oriented UCITS equity funds. The selected UCITS are only Article 8 and Article 9 SFDR products, as these are deemed more likely to obtain the EU Ecolabel than “grey” funds.

The study focuses on the calibration of the thresholds for the quantitative criteria.

The first criterion requires that 50% of the portfolio is invested in activities aligned with the EU Taxonomy. The ESMA underlines the current challenges faced with such criteria, due to the lack of available data and to the fact that the disclosure regulations do not – and will not - cover all EU companies.

Assessing the alignment of the UCITS with the Taxonomy, the study shows that only 26 sustainability-oriented funds have a portfolio meeting the 50% Ecolabel thresholds, which represents less than 1% of the sample. It is also interesting to note that, out of the 26 funds, 16 are financial products framed within Article 9 SFDR.

The second and third quantitative criteria refer to specific environmental and social exclusions, requiring that no more than 5% of the turnover of investee companies is deriving from selected sectors, such as the use of pesticides for agricultural activities, fossil fuels’ related activities for the energy sector, or activities violating the rights or minority’ and indigenous communities. Assessing the compliance with such criteria is quite difficult, given that the relevant information is at the level of the investee companies, and not of the portfolio.

Regarding the exclusion criteria, the study shows that 63% of the sample of UCITS is complying with the 5% threshold for fossil fuel exposure. Other requirements, such as tobacco and controversial weapons, are met by more than 78% of the sample, which means that the proportion of combined UCITS meeting the second and third criteria would amount to 48%.

The study concludes that only 0.5% of the existing UCITS sample would be eligible to the EU Ecolabel for meeting the quantitative criteria.

3. Conclusion

As outlined by the ESMA analysis, investment funds managers are facing difficulties accessing accurate data in the sustainable sector. This would namely explain the low proportion of funds investing in Taxonomy-related activities. However, the number of funds which do not meet such criteria and are however claimed as “sustainability-oriented” is also a risk to be addressed, for the soundness of the sustainable finance market.
While the development of an Ecolabel for financial products seems essential to answer the ever-growing demand for sustainable products, the market would need a transition period in which relevant data would become progressively available by the underlying investments.

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