Sustainable Fund Labels: Diverse Definitions of Sustainability

Sustainable financial products are marked with an increasingly large list of tags, from green, sustainable, socially responsible to thematic ESG, water, carbon or impact funds, and not every investor might know how to make sense of these terms. Sustainable fund labels can be one way to signal to the market that the fund has a dedicated responsible investment strategy.

SRI fund labels are aimed at defining minimum requirements for sustainable funds while leaving room for the investor’s interpretation. For the moment, the labels and their attribution are local in nature and promoted by national authorities. Nevertheless, foreign asset managers marketing products in any of the relevant countries may also choose to apply the local labels. At the same time, a European ecolabel is under development as part of the work from the European’s Technical Expert Group (TEG) for Sustainable Finance[1]. After several stakeholder consultations rounds, the EU Ecolabel criteria are expected to be included in European regulation in the spring of 2021. Although the local labels will likely coexist, the availability of a European-wide fund label will further determine the blueprint for sustainable investments in the European retail market. This is a welcome development because a more widely known label might increase the understanding and accessibility of sustainable funds to retail investors.

The criteria are commonly process-oriented, focusing on verifying whether ESG analysis is applied to select assets in the portfolio and that complete and comprehensible reporting is available to clients.

Additionally, some labels apply minimum exclusion criteria for unsustainable or controversial business practices. Where activity-based exclusion criteria are required this usually concerns at least fossil fuels and controversial weapons with varying thresholds.

Using a common vocabulary

Fund labels focused on climate topics often also include a minimum percentage of investments in sustainable or ‘green’ activities, based on a specified taxonomy. These taxonomies are currently based on several different conventions. Examples of conventions that underlie climate-focused fund labels are:

• The International Development Finance Club Green Finance Mapping (LuxFlag Climate Finance),
• The FTSE Environmental Markets Classification System,
• The HSBC Climate Change Structure (LuxFLAG Environment),
• The International Capital Market Association’s Climate Bonds Initiative (French Greenfin and Nordic Swan)[2].

The diverging taxonomies make it difficult for asset managers to apply multiple fund labels and for investors it complicates the comparison of funds. This will, for a large part, be solved by the EU Taxonomy, that the European TEG on Sustainable Finance created and continues to develop to provide a technically robust classification system on what business activities are considered environmentally sustainable. It remains to be seen whether the local labels will also adjust their criteria to align them more closely to this European common language.

Ratings and labels

Like sustainable fund labels, the emergence of sustainable fund ratings has also provided means of comparison of ESG performance of funds to investors. Nevertheless, there are important differences between the interpretation of the two signals[3].

• While labels are obtained on the fund managers initiative, fund ratings can be attributed to all funds, regardless of whether it has a dedicated ESG strategy.
• Although some of the fund labels create differentiation in the form of a grading system, most labels do not distinguish between funds once the label has been accredited. Ratings lend themselves better to compare amongst funds.
• Fund ratings assess the outcomes of the aggregate company ESG ratings in a fund, while fund labels mainly reward a well-defined selection and investment process that considers ESG criteria. The process might, for instance, include a voting policy and corporate engagement activities which are not captured in ratings. Therefore, it could be argued that ratings provide an idea of the ESG performance of the investments in the portfolio, while fund labels provide more information on the fund manager’s intention and approach.

Consequently, fund labels can provide investors with a standard that facilitates clarity and communication about how sustainability has played a role in the selection process while ratings provide a means of comparison of the investments that make up the fund. In some cases, funds with low ESG Ratings might hold a sustainable fund label and high ESG fund ratings can be achieved without applying a label. Investors can choose to be guided by either or both signals depending on whether they care most about the ESG performance of the current investments in the fund or by the intention of the fund manager, the selection process and the minimum exclusions. With the growing range of SRI fund labels and ESG rated funds, investors now have increased possibilities to express their reference for sustainably managed funds.

Sources:

[1] Second Technical Report with scope and criteria proposals EU Ecolabel for Financial Products. December 2019 https://susproc.jrc.ec.europa.eu/Financial_products/documents.html
[2] Novethic: Overview of European Sustainable Finance Labels. June 2019. https://www.novethic.com/sustainable-finance-trends/detail/overview-of-european-sustainable-finance-labels.html
[3] EFAMA opinion on fund ESG ratings and labels. 2017 https://www.efama.org/Publications/Public/Responsible_Investment/EFAMA_opinion_fund_ratings_labels.pdf
Austrian Umweltzeichen. Ecolabel guideline 2016. https://www.umweltzeichen.at/file/Guideline/UZ%2049/Long/Ec49_R4a_sustainable_Investment_products_2016.pdf
Febelfin Quality Standard for Financial Products. February 2019. https://www.febelfin.be/sites/default/files/2019-02/quality_standard_-_sustainable_financial_prodpdf
FNG-siegel criteria https://www.fng-siegel.org/siegelkriterien.html
Greenfin label criteria. April 2019. https://www.ecologique-solidaire.gouv.fr/label-greenfin
Label ISR. annexe 2: terms of reference of the label. 2015. https://www.lelabelisr.fr/wp-content/uploads/2018/06/annex_2_-_referentiel_english.pdf
Nordic ecolabel criteria – June 2017 https://www.svanen.se/contentassets/653430c81fae41418c2b544a2205abf6/criteria-document_101_investment-funds-101_english.pdf
LuxFlag website. April 2020 https://www.luxflag.org/label-landing-page.html