New CFA Institute report argues ESG Fund classification needs more rigour
A report published today by the CFA Institute Research and Policy Centerseeks to improve ESG fund classification through an in-depth review of current classification frameworks and rigorous definitions of fund-level features, as well as providing examples of rigorous definitions in practice.
CFA Institute
The paper, How to Build a Better ESG Classification System, examines a selection of existing regulator and industry ESG fund classification frameworks in the United States, the European Union, and the United Kingdom. It finds these frameworks are problematic when put into practice due to a lack of focus on observable features, imprecise definitions, or an incomplete logical structure for assigning funds to mutually exclusive groups.
The paper will be particularly useful for regulators establishing and tailoring rules for ESG funds and for industry participants seeking to both market and select funds. It offers guidelines, examples, and case studies to support practitioners who must deal with the complexities of ESG fund classification in practice.
Chris Fidler, Head of Global Industry Standards, CFA Institute said:
There is much disagreement about how to categorically define and identify ‘ESG funds.’ And when ambiguous terms like these are used in regulation to create special rules for certain kinds of funds, it can create significant uncertainty in the marketplace. This paper shows how to build strong fund category definitions, and we hope it ultimately leads to clearer regulation which would benefit both fund investors and fund managers.
The ultimate test of a classification system is to have different evaluators classify the same set of funds. If they do it the same way, a good system exists. If different evaluators assign the same fund to different groups, revisions are required.
The ultimate test of a classification system is to have different evaluators classify the same set of funds. If they do it the same way, a good system exists. If different evaluators assign the same fund to different groups, revisions are required.
The paper, How to Build a Better ESG Classification System, defines three observable features by which funds can be classified.
These are:
- The existence of one or more processes that consider ESG information with the aim of improving risk-adjusted returns;
- The existence of one or more policies that control fund investors’ exposure and contribution to specific systemic ESG issues; and
- The existence of an explicit statement of intent, and an action plan, to help bring about a target future state in environmental or social conditions and a process to measure progress.
Speaking on the UK’s Sustainability Disclosure Requirements (SDR), Chris Fidler added:
“SDR will give fund investors confidence that a sustainability labeled fund meets minimum standards set and enforced by the FCA. SDR will make it vastly easier for retail investors to identify funds that have a sustainability objective.”
“For funds without a sustainability label, the markets still need a reliable way to distinguish between funds that use ESG information to make risk-return decisions and funds that take a policy position on specific ESG issues. This is one of the primary needs that we explore in our new report.”
Meanwhile, on the EU’s Sustainable Finance Disclosures Regulation (SFDR), he said:
“SFDR showed that conditional disclosures -- for example, a disclosure that is made only when a fund has sustainable investment as its objective -- gives rise to a de-facto classification system in the marketplace. This is not ideal because classification systems should be intentionally designed to meet a defined set of needs.”
“For funds without a sustainable or transition label, the markets still need a reliable way to distinguish between funds that use ESG information to make risk-return decisions and funds that take a policy position on specific ESG issues. This is one of the primary needs that we explore in our new report.”
The How to Build a Better ESG Classification System paper is available here.
About CFA Institute
As the global association of investment professionals, CFA Institute sets the standard for professional excellence and credentials. We champion ethical behaviour in investment markets and serve as the leading source of learning and research for the investment industry. We believe in fostering an environment where investors’ interests come first, markets function at their best, and economies grow. With more than 200,000 charterholders worldwide across 160 markets, CFA Institute has 10 offices and 160 local societies. Find us at www.cfainstitute.org or follow us on LinkedIn and X at @CFAInstitute.
About the CFA Institute Research and Policy CenterThe CFA Institute Research and Policy Center brings together CFA Institute expertise along with a diverse, cross-disciplinary community of subject matter experts working collaboratively to address complex problems. It is informed by the perspective of practitioners and the convening power, impartiality, and credibility of CFA Institute, whose mission is to lead the investment profession globally. Visit the Research and Policy Center at http://rpc.cfainstitute.org