The European Supervisory Authority (ESA) has called into question what can be considered Article 8 or 9 under the Sustainable Finance Disclosure Regulation (SFDR) in a letter sent to the European Commission.

The letter, sent by the ESA – a joint committee that includes the European Securities and Markets Authority (ESMA) – on 13 May, asked for several clarifications around the regulation, but most notably queried whether a government bond fund with an ESG investment strategy can rightly be labelled either Article 8 or 9.

It is the latest sign that the authorities are trying to get to grips with the “vague” definitions of the regulation that has led to fears it could increase greenwashing across the industry.

The committee notes the reference to good governance in Article 8 only relates to companies while the definition of ‘sustainable investment’ in Article 9 “specifically relates to ‘investee companies’”.

The ESA went on to ask: “Can a financial product investing solely in government bonds while applying an ESG investment strategy be considered to fall under either Article 8 or Article 9 SFDR?”

The European Commission’s decision could affect ETFs such as the Xtrackers Global Government Bond UCITS ETF (XZWG) which launched in December and is currently labelled Article 8.

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XZWG tracks the FTSE ESG Select World Government Bond Developed Markets index which aims to provide a “meaningful” ESG tilting with a “comprehensive ESG sovereign bond assessment and weighting framework” using 41 ESG indicators.

The index will overweight higher ESG performing countries and underweight lower-performing countries while excluding countries not designated as “free” by the non-profit organisation Freedom House.

Other ETFs such as the L&G ESG Emerging Market Government Bond 0-5 Year UCITS ETF (EMDG) and the UBS JP Morgan Global Government ESG Liquid Bond UCITS ETF (EGO) are also classified as Article 8.

The ESA also called into question issues around good governance.

“If a financial product disclosing under Article 8 or 9 does not invest in companies with good governance, is that product able to continue disclosing under Article 8, 9 and 11 SFDR?” it said.

The definition of the product classifications is significant. According to a survey by Brown Brothers Harriman, 28% of European respondents said they rely on SFDR when evaluating ESG ETFs, more than any other tool.

If an asset manager has classified a strategy as Article 8 but does not meet the requirements under ‘level two’ of SFDR, it could be downgraded to Article 6, the non-sustainable label.

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