In recent years, the EU has launched some truly innovative and ambitious regulatory initiatives, from the EU Taxonomy, to the SFDR and MiFID II, all seeking to channel capital flows toward sustainable investments. As with all pioneering projects, however, it takes time and expertise to translate the interlinked regulatory frameworks into user-friendly solutions.
To help Nordic investors navigate through this increasingly complex regulatory environment, on 16 March, two experts from Clarity AI joined NordSIP for an informative and interactive webinar. Victor Fernandez, Director of Product, and Lucía Vega-Penichet, Sustainability Product Specialist, shared some valuable insights from their latest research and analysis and answered questions from the audience.
Just how sustainable are Article 9 funds
Clarity AI’s research team has analysed 15,000 funds, zooming in on 750 Article 9 funds in particular, in order to understand to what extent these can be considered “sustainable investments”. Their findings are summarised in a whitepaper titled SFDR: Just How Sustainable are Article 9 Funds. According to Vega-Penichet, the evidence shows that many Article 9 funds are falling short of expectations.
The researchers use a three-step methodology to assess the sustainability of the funds, taking their lead from the regulation itself. First, they look at the investments’ contribution to a sustainable objective by assessing the performance on mandatory principal adverse impact (PAI) indicators and alignment with the EU Taxonomy and the UN SDGs. Thereafter, they assess the application of the Do No Significant Harm (DNSH) principle. Finally, they analyse exclusions based on good governance.
The top three findings are cause for concern. Of the 750 Article 9 funds reviewed by Clarity AI, nearly 20% have more than 10% of their investments in companies violating UNGC principles or the OECD Guidelines for multinational enterprises. 40% have more than 5% exposure to such companies.
Moreover, the research reveals that nearly 10% of Article 9 funds have more than 10% exposure to fossil fuels. In total, the Article 9 funds analysed are investing in over 1,250 companies that produce or participate in the distribution of fossil fuels. While some of these companies derive a small share of their revenues from activities related to fossil fuels, more than 500 companies earn the majority of their revenues from these activities.
Beyond these concerns, 38% of Article 9 funds have more than 10% of assets invested in companies with very poor performance in mandatory quantitative PAIs. While they claim to be sustainable, these funds invest in companies that are among the 5% worst performing in at least one of the mandatory PAI indicators. For example, 75% of the Article 9 funds invest in at least one company with no women on the board.
With the entry into force of the SFDR 2.0 in January this year, the industry has seen a wave of downgrades from Article 9 to Article 8 funds. “It is tempting to think that there was some malicious intent or greenwashing involved,” says Vega-Penichet. “However, we believe this is just symptomatic of the uncertain regulatory landscape. As things become clearer, asset managers adapt to the rules.”
According to Vega-Penichet, fund providers are facing two main challenges. One of these is trying to interpret the complicated rules, which she compares to shooting at a moving target. The second one is sustainability data.
Closing the gap in sustainable investment data
Clarity AI was founded in 2017 with a singular mission: to bring societal impact to markets. The firm offers a platform called Sustainability Tech Kit which, as the company name indicates, uses artificial intelligence (AI) to bridge the data gap in sustainable investments. According to Fernandez, Clarity AI aims to help investors by providing three essential elements: the data, the methodology and the tools they need to make informed decisions regarding sustainability.
Given the lack of reliable and consistent sustainability data and the poor coverage in this area, the company uses AI to avoid mistakes by reading data from different sources and using algorithms to identify the best data point for each company and each metric. The company also uses Natural Language Processing (NLP) to analyse more than a hundred thousand news every day and extract data points that can be relevant to sustainable investors.
Clarity AI also aims to help investors overcome the subjectivity embedded in many ESG rating methodologies. The company has developed fully systematic and objective methods based on raw data.
“We know that investors need the data in their workflow, easy to use,” says Fernandez. “Being tech natives, we can leverage our capabilities to integrate our data seamlessly into their processes.” This way, Clarity AI’s clients can generate the reports they need and do the analysis at portfolio level.
The Nordic challenge
According to Fernandez, the Nordics were early in embracing sustainable investing. In a way, however, this creates a unique challenge for them. Whereas other countries in the EU are now implementing the Taxonomy and the SFDR as their first and only framework, Nordic investors need to adapt their existing frameworks to the regulation. This can result in a misalignment between their former and current strategy.
“It is important to remember, however, that the new regulation is not just a problem,” reminds Fernandez. “It creates opportunities as well.” It is evident that the appetite for Article 9 funds is growing, so the effort to adapt to the framework is definitely worth it. Moreover, with the help of technology, transparency and expertise, this can be done smoothly and deficiently, as the Clarity AI experts assure us.