New Regulations Could Lead to $40 Billion in Divestments from EU Sustainable Funds

A recent report by investment research firm Morningstar has revealed that two-thirds of funds in the EU labelled with sustainable or ESG-related terms may need to make significant changes to comply with new regulations aimed at preventing greenwashing. If all funds were to keep their current names, stock divestments could reach as high as $40 billion.

The European Securities and Markets Authority (ESMA) recently released guidelines requiring funds using ESG, sustainability, or impact terms to meet specific investment thresholds and follow exclusion criteria for Paris Aligned Benchmarks. Funds not meeting these requirements may need to sell assets or rebrand. Additionally, a new “transition” category has been introduced for funds that do not meet the strictest criteria but still aim to improve sustainability efforts.

Morningstar’s analysis identified thousands of funds that could be affected by the new regulations, with many potentially holding companies that breach the exclusion rules. The energy sector was found to be the most exposed, followed by industrials and basic materials. Companies like TotalEnergies, Shell, and Tencent Holdings were among those at risk due to their violations of sustainability principles.

The guidelines are set to take effect in the coming months, with existing funds given time to comply. Morningstar anticipates a significant reshaping of the ESG fund landscape in Europe as funds adjust to meet the new standards. While the changes may lead to substantial divestments, they also aim to bring greater clarity and transparency to sustainable investing practices.

Hortense Bioy, Head of Sustainable Investing Research at Morningstar Sustainalytics, emphasized the potential impact of the guidelines, noting that they could prompt thousands of funds to alter their names or portfolios. The ultimate goal is to raise the bar for ESG products and ensure that investors have a clear understanding of where their money is being invested.

For more details, you can access the full Morningstar report [here].