COPENHAGEN: The US stock market has emerged as the most exposed to divestment after the European Union (EU) unveiled new rules limiting how freely asset managers can attach environmental, social and governance (ESG) labels to their funds.

The European Securities and Markets Authority (ESMA) said last month that investment funds with ESG labels or equivalent terms will need to have at least 80% of their assets under management in something that’s actually related to environmental, social or governance goals. They also can’t invest in certain assets such as the largest oil and gas producers.

For fund managers overweight US stocks, that requirement looks set to have outsize implications, according to an analysis by Morningstar Inc.

“The United States could see the largest impact in terms of stock market value,” Morningstar said in a report.

Some 42% of the potential stock divestments that may be triggered by ESMA’s new rule will hit the US, measured in terms of stock market value, Morningstar estimates. France is a distant second, at 17%, followed by China at 12%, the research shows.

Another alternative is that fund managers decide not to go to the trouble of redesigning their portfolios and instead rename their products.

Arthur Carabia, director of ESG policy research at Morningstar Sustainalytics, said in a post on LinkedIn that the researcher expects “many funds to drop ‘ESG’ and related terms from their names”.

Some will opt for terms that carry less onerous minimum requirements under the EU’s new rules, such as “transition,” he said.

Morningstar identified about 4,300 EU funds with ESG or sustainability-related terms in their names that may be affected by ESMA’s new guidelines.

Noting that funds can’t invest in companies on an exclusion list under the EU’s Paris-aligned benchmark rules, Morningstar estimates that more than 1,600 funds will need to divest stocks worth a total of up to US$40bil, if they want to keep their current names.

The sectors that are most vulnerable to divestment as a result of ESMA’s new rules include energy, industrials such as railroads and defence, and basic materials, Morningstar said.

Among US companies identified by Morningstar as being at risk of divestment from EU-domiciled ESG funds are Exxon Mobil Corp, Schlumberger NV, Wells Fargo & Co and Chevron Corp.

Regulatory authorities in EU member states must incorporate the guidelines in their supervision of the market, or state why they don’t intend to comply.

Hortense Bioy, head of sustainable investing research at Morningstar Sustainalytics, said she doesn’t expect them to provide a comprehensive list of ESG or sustainability terms.

“There will be some room for interpretation,” she said in an interview.

The naming requirements are among the latest efforts by the EU to address gaps in its landmark Sustainable Finance Disclosure Regulation (SFDR).

The finance industry will shortly find out if they’ll have to abandon almost five years of work figuring out SFDR and start anew.

The EU’s regulators for banks, insurers and the market said this week they are finalising a joint opinion on SFDR, including proposed changes.

Their conclusions will weigh heavily on how the European Commission and lawmakers tackle the problems plaguing SFDR once the upcoming elections are over and a new parliament is seated.

In the meantime, asset managers will look to the naming requirements to stay on the right side of regulators.

Given the regularity of greenwashing accusations, asset managers “will want to be careful”, Bioy said.

New rules limiting how freely asset managers can attach the ESG label to funds sold in Europe promise to trigger a widespread purge across the industry, according to a fresh analysis by Morningstar Sustainalytics.

The European Central Bank confirmed that it’s preparing to fine a number of lenders after they failed to make adequate progress in addressing risks posed to their business by climate change.

 - Bloomberg