Investor interest in sustainability has shifted significantly toward companies facilitating a ‘brown to green’ transition, according to a report by the European Securities and Markets Authority (ESMA).
The report reveals that net inflows into transition-focused funds in the EU have nearly doubled those into environmental funds over the past two years. This marks a move away from investments in already-green companies, as investors now prioritize firms transitioning to sustainability.
ESMA’s Trends, Risks and Vulnerabilities report emphasizes the need for both public and private funding to meet EU Green Deal objectives. However, the regulator expressed concerns about the slowdown in ESG investment growth, noting that political pressure, particularly in the U.S., has contributed to this trend. In the first half of 2024, ESG fund investments remained flat, with Article 9 funds experiencing net outflows of €9.4 billion, while Article 8 funds saw net inflows of €50 billion.
Despite this, transition-focused funds have shown promising growth. Although smaller in scale, with assets under management (AUM) of €39 billion compared to €260 billion for environmental funds, their cumulative inflows have outpaced their green counterparts over the past two years.
ESMA’s findings follow its recent recommendations to create a clearer categorization system for sustainable and transition investments, and to expand the EU Taxonomy to cover transition activities. The regulator suggests that a new Transition category for financial products could support investments in firms aiming to become sustainable over time.
In ESMA’s new report, the regulator noted that while a clear framework or definition for transition funds does not yet exist, these funds already appear to be taking a homogeneous investment approach, with a much higher degree of similarity relative to green funds.
Among the key differences from green funds, the report found that transition funds tend to have much higher exposure to the fossil fuels sector, at a level similar to that of funds not designated as sustainable.
Transition funds’ fossil fuel investments, however, were highly concentrated in “firms rated by ESG rating providers as environmental leaders within their sector, and with the potential to contribute to the EU’s environmental objectives,” and also tended to favor green bonds issued by fossil fuels and utilities sector firms. Transition funds also had much higher concentration in securities issued by utilities firms, which ESMA noted “suggests that ‘transition’ fund strategies may be tilted towards sectors enabling the transition more broadly.”
Click here to access the ESMA TRV report.
