Last checked at 
* Managers rush to meet Europe's new regulatory regime
* Some 'sustainable' funds buy fossil fuel, tobacco shares
* Fund firms say vague SFDR definitions to blame
* EU says rules about disclosure, not green labels
By Tommy Wilkes
LONDON, Aug 19 (Reuters) - If you want to invest in a fund
branded as sustainable under new European Union rules, you're
spoilt for choice. But you may end up owning shares in oil
companies, mining conglomerates or tobacco firms.
A Reuters analysis of funds marketed to retail investors
increasingly hungry for anything green shows asset managers are
adopting a wide range of strategies to justify the sustainable
label since the EU brought in disclosure rules in March.
The EU's Sustainable Finance Disclosure Regulation (SFDR) is
an attempt to deliver transparency for investors focused on
environmental, social and governance (ESG) issues but fund
managers say the definition of sustainability is too vague and
has created confusion about what makes the cut.
Take the Allianz Global Water fund.
It actively invests in companies that improve the supply,
management and quality of water and is marketed as falling under
Article 8 of the SFDR, which means it is a fund that promotes
"among other characteristics, environmental or social
characteristics, or a combination of those characteristics".
Now take one of Legal & General Investment Management's
(LGIM) Article 8 exchange-traded funds (ETF).
The L&G UK Equity UCITS ETF tracks the Solactive Core United
Kingdom Large & Mid Cap Index, which excludes coal miners and
firms that make weapons such as cluster bombs or have breached
U.N. principles https://www.unglobalcompact.org/what-is-gc/mission/principles
on corporate values.
Its top 10 holdings are the same as for L&G funds tracking
the FTSE 100 index that don't carry the Article 8 label and
include oil giants BP and Royal Dutch Shell,
miner Rio Tinto and British American Tobacco.
L&G said the fund was considered Article 8 because it
promotes sustainability characteristics by applying LGIM's
Future World Protection List and this was a "binding element" of
the investment process.
"The lens we should use is what is right. It's not just
about what is legally required because it seems not very much is
legally required," said Eric Christian Pedersen, head of
responsible investments at Nordea Asset Management.
GREEN RUSH
The new EU rules have sparked a rush by investment firms to
badge products as sustainable as they seek to grab a share of
the booming market in sustainable mutual funds that hit a record
$2.3 trillion in the second quarter.
From March 10, the rules automatically placed all investment
funds into a coverall Article 6 category. Managers could then
upgrade them to Article 8, or Article 9 which is for products
with an explicit sustainable investment objective.
The investment industry has dubbed Article 8 funds "light
green" and Article 9 "dark green", though the EU regulations do
not use those terms.
A European Commission spokesperson said its rules were
designed to ensure funds were transparent about the
sustainability of products so investors could make choices, and
was not a labelling scheme.
Reuters asked 20 of the biggest fund houses for a list of
products they market as Article 8 or 9.
An analysis of the funds of the 14 firms that replied shows
some Article 8 products have limited claims to sustainability,
such as those tracking conventional stock and bond indexes,
investing in fossil fuels or buying debt from countries with
weak ESG standards such as Saudi Arabia and Nigeria.
Some claims hinge on funds excluding securities they would
not have bought anyway, based on the index being tracked.
For some in the industry this represents so-called
greenwashing, where the benefits of a business or asset are
exaggerated to attract environmentally aware investors.
Hortense Bioy, director of sustainability research at
Morningstar, said Article 8 funds ranged from climate-themed
green to "very, very light green", excluding just a few firms.
"Managers need to ask if they are even relevant," she said.
"That is the key message: investors shouldn't expect anything
from Article 8."
INDEX TRACKERS
Industry experts say none of the asset managers is breaking
any rules. Managers determine themselves which article to apply
and Brussels does not check whether claims are justified.
The Reuters analysis shows some managers are more likely to
brand funds as sustainable than others.
Two of Europe's biggest firms, Alliance Bernstein and AXA
Investment Management, classify nine in every 10 euros of assets
they manage under the scope of SFDR as Article 8 or 9, according
to data they supplied to Reuters.
Others such as Pictet Asset Management and Allianz Global
Investors place a little over half of their relevant assets in
those categories, their data showed.
Morningstar data published in July shows a third of
the assets falling under SFDR are now billed as Article 8 or 9,
with Article 6 products disappearing from recommendation lists
sent by investment advisers to retail investors.
Many Article 8 funds have clear sustainability criteria,
such as strategies that invest in businesses with the lowest
carbon impact in their sectors, or Allianz's water-focused fund.
For others, that's not always the case. Candriam's Cleome
Index Europe Equities is another Article 8 product. It tracks
the MSCI Europe index but excludes companies that don't comply
with the U.N. principles.
Critics say such exclusions are very limited.
When asked for an example, Candriam did not point to any
company expelled from the U.N. list that is also part of MSCI
Europe. The Candriam fund's top 10 holdings replicate the index.
A Candriam spokesperson said it also applies exclusions on
companies materially involved in controversial weapons, tobacco
and thermal coal, and the Cleome equity fund uses proprietary
ESG analysis relative to the benchmark, justifying Article 8.
Morningstar analysis shows one in four Article 8 funds has
exposure to companies involved in controversial weapons and one
in five to tobacco. A third of Article 8 and 9 funds have more
than a 5% exposure to fossil fuel firms.
'NASTY' ESG?
Demand for funds with a sustainable label is soaring.
"There is a clear commercial opportunity," said Eric
Borremans, head of ESG at Switzerland's Pictet Asset Management,
which classes 57% of its assets as Article 8 or 9.
Borremans said Pictet had no index-tracking Article 8 funds
but planned to apply the label to some after incorporating more
exclusions.
U.S. investment giant BlackRock told Reuters it
expected to exceed a target of putting 70% of its new, or
rebranded, products this year under Articles 8 or 9.
Some funds use ESG thresholds to justify sustainable labels.
JPMorgan Asset Management says 51% of the securities in its
Article 8 range must carry an ESG score in the top 80%. These
are scores fund firms or third-party providers give companies
based on ESG metrics such as carbon usage, governance or human
rights in supply chains.
Critics say such thresholds are too weak.
"You have funds saying most of our holdings are not nasty
and therefore I'm ESG," said Pedersen at Nordea, which requires
100% of its Article 8 holdings be above a minimum ESG score.
The JPMorgan threshold, for example, also means 49%
of companies in its funds could rank in the bottom 20% for ESG
goals, although the funds exclude sectors such as tobacco,
controversial weapons and coal miners.
JPMorgan Asset Management did not respond to questions about
ESG scores. A spokesperson said the firm remained "focused on a
thoughtful and thorough approach to the implementation of SFDR".
Pictet's Borremans said funds interpreting the rules loosely
now can get away with it, but strategies sailing close to the
wind will eventually be exposed.
By next year, the EU will flesh out its taxonomy -- a list
of environmentally sustainable economic activities -- and from
July 2022 funds must detail how they meet sustainability
criteria based on the EU's Regulatory Technical Standards (RTS)
that will clarify disclosure requirements.
"It could hurt the reputation of an asset manager to offer
financial products as falling under Article 8 and 9 or as
taxonomy aligned if this cannot subsequently be backed when the
RTS enters into application," the European Commission
spokesperson said in emailed comments.
Amundi's head of cross-border product, Florian
Schneider, said SFDR rules made clear products with minimal
exclusions were Article 8.
"The danger is everyone blindly assuming all Article 8 funds
offer the same level of ESG integration when there are very
different shades of green."
($1 = 0.7274 pounds)
(Additional reporting by Simon Jessop; Editing by Sujata Rao,
Alexander Smith and David Clarke)
