The Danish Finanstilsynet (FSA) has said funds categorised under Article 9 of the Sustainable Finance Disclosure Regulation (SFDR) can only hold securities with demonstrable sustainable credentials. 

In an interview with FinansWatch, the regulator said if these funds invest in industries such as fossil fuel exploration and production, then product managers will have to prove any companies they are exposed to do not damage the environment. If a product is equity-based, it will also have to set out how each security contributes to sustainable goals. 

Theodor Christensen, leader of the team for inspection of sustainable finance at the FSA, said: “The EU Commission’s response to a number of legal interpretation questions from the EU financial authorities states that the underlying investments in an Article 9 product must all qualify as sustainable investments as defined by article 2, paragraph 17 of the disclosure directive.”

Christensen stressed this applies to all Article 9 products, including passively managed funds. He added the benchmark directive requirements must be applied alongside the terms of article 2, paragraph 17. 

“Following a climate benchmark does therefore not necessarily mean the providers of sustainable financial products are relinquished from the responsibility of making sure the product lives up to 2, 17, as the other rules must still be applied,” Christensen noted.

The FSA’s point of calling out passive funds in particular chimes into a common debate in the industry, where asset managers explain away their unfavourable exposures by stating they are merely tracking an index.

The question then becomes one of where responsibility for protecting the ‘dark green’ credentials of Article 9 funds should lie. On the one hand, MSCI, S&P Down Jones Indices and FTSE Russell account for 80% of all passive fund assets in Europe, so they have considerable influence in deciding what goes into the growing range of sustainable indices being launched – especially given their recognisable names will end up being a selling point for the ETFs that track their benchmarks.

On the other hand, ETF issuers themselves regularly collaborate with index providers to create benchmarks which are custom-built for their needs. So, although the finished product may be passive, asset managers can end up having considerable influence in what goes into a basket – so they cannot shift blame entirely.

Alternatively, it would be worth turning an eye to investors themselves. Not only is there not a universal definition for ESG investing, there is no common understanding of what purpose ESG investing should serve. For some, it is about offering a slightly tilted version of beta, where the risk profile of an exposure is improved and returns are still a priority. For others, the ethical and principled element is primary, even to the detriment of risk-adjusted returns.

This lack of consensus on ESG is equally applicable within the context of the SFDR itself. In fact, a recent study from non-profit group EFAMA found SFDR Article 8 funds made up 92% of UCITS product market share in Sweden at the end of Q1, whereas in Germany the use of spezialfonds and stricter regulation meant SFDR Article 8 funds claimed just 6% of UCITS assets.

With the Danish FSA drawing its line in the sand on SFDR Article 9, the key now will be looking at how their approach to applying the landmark regulation differs from other EU member states, and how changes to the EU taxonomy – which now touches on industries such as nuclear power and natural gas – influences their understanding of sustainable investment.

Overall, though, further clarification on SFDR and how countries decide to interpret it will likely have to wait until after the eventual arrival of SFDR phase two in the new year.