Industry Updates

Passive funds ‘disproportionately’ impacted by ESG fund naming rules

$19bn worth of stocks impacted by exclusion rules, Morningstar finds

Lauren Gibbons

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Passive funds will be “disproportionately” impacted by the EU’s updated ESG and sustainability fund naming rules, Morningstar Sustainalytics research has found.

Out of its 1600 funds impacted by the new rules, just 21% (354) are ETFs and index funds. However, they account for almost half (45%) of the $40bn worth of stocks affected by the exclusion rules.

It means that passive funds would need to divest from $19bn worth of stocks to meet the European Securities and Market Authority’s (ESMA) requirements, or remove ESG or sustainable from their fund name.

Under the rules, published last month, funds with the term ESG or sustainable in their name must have at least 80% of investments tied to environmental or social characteristics.

In addition, funds with ESG or sustainable in their name must also not include fossil fuel companies, adhering to Paris-Aligned Benchmark (PAB) exclusion metrics.

Morningstar said that in light of the changes they expect a portion of environmental and SRI “best-in-class” type passive funds to change their underlying indexes to align with PAB exclusion metrics.

The report found the Xtrackers MSCI AC World ESG Screened UCITS ETF (XMAW) held the highest number of stocks out of any ETF that would be affected by the ESMA’s updated guidelines at 108, 6.7% of the total portfolio.

The UBS MSCI ACWI ESG Universal Low Carbon Select UCITS ETF (AWECHF) followed closely behind with 107 exclusion stocks held, at 6.5% of the total portfolio.

Morningstar said that the large number of exclusion stocks held in passive funds can be explained by the large number of holdings in their portfolios versus active funds.

ESMA said the existing funds will have roughly six months to adhere to the new rules when the come in to force in three months.

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