French SRI fund label changes to hit EM funds

No-go jurisdictions pose divestment question for managers

Emerging markets funds face losing the French socially responsible investment (SRI) label if they do not divest from a number of jurisdictions.

The Investissement Socialement Responsable (ISR) label announced stricter eligibility criteria in December 2023, including funds becoming ineligible if they invest in companies involved in new projects related to the exploration, exploitation and refining of fossil fuels, or if they invest in any of 118 listed countries.

Some 202 fund management companies, 1,228 funds and €766bn of assets currently enjoy the label, according to the ISR website.

The criteria will apply from 2025 for those using the label already and from March 2024 for funds awarded the label from then onwards.

No-go jurisdictions

A new label reference system, cites three locations to check for no-go jurisdictions; the EU list of non-cooperative jurisdictions for tax purposes, the Financial Action Task Force (FATF) blacklist or grey list and countries scoring below 40/100 on Transparency International’s Corruption Perceptions Index.

Issuers where the registered office is on the EU list of non-cooperative jurisdictions for tax purposes, or where the headquarters are in a country on the FATF lists are excluded for governance criteria. Sovereign bonds issued by countries on those lists – or by countries that score below 40/100 on the Corruption Perceptions Index – are also excluded.

Fund exposure

ESG Clarity has looked at emerging markets (EM) funds with the ISR label and found there are around 30, according to the figures published by ISR in January.

Excluded countries that regularly crop up in emerging market funds include South Africa, Turkey, Brazil and Mexico. Almost half of the 24 countries on the MSCI Emerging Markets index appear on one of the three country lists for exclusion.

The 11 MSCI Emerging Markets Index countries on ISR’s exclusion lists

Country present on MSCI EM indexScore below 40/100 on Transparency International’s Corruption Perceptions Index  Appear on Financial Action Task Force (FATF) blacklist or grey list  
South Africa 
United Arab Emirates 

Diversification challenge

Suresh Mistry, Alquity head of sustainability, said his firm may need to look again at having the label as it could put too many limits on diversification.

“Alquity has had the ISR label certification for six years and we’re very proud of that. The fact it is externally audited gives our clients huge confidence in our process.

“While we encourage improvements and changes to the label standards, as an emerging market investor some changes may lead us to revisit whether all our funds apply for certification. If a large number of countries in the MSCI EM index are excluded it does make it almost impossible to run a broadly diversified EM strategy,” said Mistry

He noted Alquity funds focus on detailed ESG analysis at the stock level due to the fact ESG at a country level is highly nuanced.

Stricter criteria

Before the new eligibility criteria were published they received a vote of confidence from France’s finance minister, Bruno Le Maire. He announced in November last year he would support the ISR committee’s proposal for stricter eligibility criteria.

Mikkel Bates, regulation manager at FE fundinfo, said there seems to have been broad support for stricter rules.

“France has always put itself at the forefront when it comes to sustainability, so it is no surprise that they have reviewed their label criteria. This is the first significant review of the label since it was introduced in 2016 and investors’ expectations have moved on since then.

“The review has taken about two years and involved a lot of consultation with local fund groups, most of whom seem to be supportive of tightening the rules.”

Bates said exclusions are only one part of the sustainability story but they are very easy to monitor, so compliance with the rules is easy to check.

He also noted the investment community is currently waiting to see what will happen with EU Sustainable Finance Disclosure Regulation (SFDR) and the outcome there might work well for ISR.

“[One unknown] is what will come out of the consultation on the SFDR, which talked about the possibility of turning it into an EU-wide labelling regime. Some groups may decide down the line that using whatever labels come out of that will be sufficient, but there will still be others that want to go to a higher level, and that may be part of what is behind these changes, so French sustainability funds will be seen as ‘even better’ than other EU sustainability funds.”

Risky trade offs

However, Hortense Bioy, Morningstar global director of sustainability research, said restricting an investment universe in this way always comes with risks.

“The more you restrict an investment universe the more difficult it becomes to deliver returns compared to the overall market.

“There is a trade off in terms of diversification – if you’re taking out some countries it becomes more concentrated so you’re increasing your financial risk.”

Bioy also questioned if it was indeed responsible to pull assets from countries requiring funding for the green transition. She cited the example of Brazil – which appears on the exclusion lists – where pro-environmental president Lula was re-elected in 2022.

She agreed with Bates that fund groups will be playing a wait and see game this year, not only with SFDR but also with elections – such as the presidential election in Indonesia – and other macro issues, to see if the ISR country exclusions work for their portfolios.

Ultimately, she said, educating investors may be more effective than increased screening:

“When it comes to exclusions, investors want more and more minimum standards and the regulator wants to provide more safeguards to investors to mitigate greenwashing.

“But a lot of the greenwashing accusations [come about] because there’s a gap between investors’ expectations and what’s in their portfolios.

“You need to educate investors if you don’t want them to be surprised.”

ISR was contacted for comment but did not respond by the time of publishing.