European ESG funds face fossil fuel showdown after French ruling

Pan-European funds claiming to invest on an environmental, social and governance basis may need to sell all their fossil fuel holdings following a ruling by the French government.

The move could lead to billions of euros worth of forced divestments over the course of 2024. 

France has ruled that funds operating under its “socially responsible” ISR label will, from the start of 2025, be barred from investing in any companies that launch new hydrocarbon exploration, exploitation or refining projects. Companies that exploit coal or “unconventional” hydrocarbons will also be off limits.

The sweeping nature of the new regulations is likely to radically reshape ESG fund portfolios.

“It is fair to assume that virtually every company focused on oil and gas exploration, production and refining is continuously looking to expand its oil and gas activities,” said Hortense Bioy, global director of sustainability research at Morningstar.

“Investors would be hard-pressed to find an oil and gas company that doesn’t plan to replace its declining production from old fields by developing new fields, be they on the oil side or the gas side.”

The stricter rules, unveiled by French finance minister Bruno Le Maire, will reverberate outside of France because many asset managers market the same ESG funds across Europe in order to minimise duplication and costs and maximise liquidity.

This is particularly true of exchange traded funds, which are typically listed on several exchanges and “passported” into other European countries.

“ETFs have been quite successful because they have been [domiciled] in Luxembourg or Ireland and can distribute across all of Europe at once by being listed on every stock exchange,” said Bioy.

Fund managers “are going to have to think hard. Do they align with the French label when the product is sold in different countries?” added Bioy, who feared a proliferation of differing ESG standards across the continent.

She said there could be as many as 15 national and European labels by 2025. “You are going to have to make a choice, [for example] say we are not going to align with the French one because we are going to align with the UK one.”

The existing 1,200 ISR-labelled funds hold €7bn of stock in traditional energy companies, according to calculations by Morningstar Direct, with 45 per cent of such funds holding oil and gas stocks.

The Tocqueville Value Europe ISR, CM-AM Europe Value, DNCA Invest Archer Mid-Cap Europe and two BNP Paribas funds all have exposures of at least 13 per cent to oil and gas companies, Morningstar said.

In euro terms, the largest positions are held by BlackRock’s iShares MSCI USA SRI Ucits ETF, at €324mn as of mid-November, the iShares MSCI World SRI Ucits ETF (€208mn), and Eleva European Selection (€171mn).

French oil major TotalEnergies is held by 161 ISR-labelled funds with aggregate holdings of €2.4bn, Morningstar found, representing 1.6 per cent of the company’s market capitalisation.

Rival energy groups Neste, Eni, Repsol, Galp Energia, BP, Shell and OMV also appear in many funds, although ISR funds may not have to sell some of these, such as Finland’s Neste.

The exclusions will also apply to fixed income funds, potentially precipitating a sell-off in the bonds of energy companies.

The French economy and finance ministry said the “strengthening” of the security selection requirements of ISR funds “make the fight against climate change a key principle of the label”.

The measures are also designed to help achieve a “progressive alignment of ISR portfolios with the [2015] Paris Agreement”, it added. A newly introduced stipulation means ISR funds must invest at least 15 per cent of their portfolios in companies with carbon transition plans in line with Paris, a number that will be progressively raised over time.

Removing any perception of greenwashing and improving clarity for retail investors are other goals of the first major tightening of the regulations since the ISR label was created in 2016.

One French fund executive, who declined to be named, said: “France has been at the forefront of sustainability for some time. The government is saying ‘we feel you have to try to direct money to certain products that are not invested in fossil fuels’.

“I think what the government is trying to do is to take a hard stance now because they feel [the battle against climate change] is not going as strong and as fast as needed.”

However, the executive said the move would reduce choice for investors, given that many French banks prioritise ISR products, and questioned if that would meet customers’ needs.

One asset management group, which also declined to be named, told the FT that “it looks like the reforms will have many impacts on the industry and asset managers, requiring additional reporting, increased access to data and greater engagement, and while many funds will be able to retain the [ISR] label, there are some whose structure is incompatible with the new requirements”.

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“The French government know that the universe will shrink,” said Bioy, with some managers not wishing to align all their existing ISR funds with the tighter regulations.

BlackRock and BNP Paribas declined to comment. Amundi said it “fully supports the new criteria for the SRI label. This adaptation, which places the fight against climate change and the transition at the heart of the label, will make it more demanding and easy to understand.

“It will finance the transition of economies by mobilising client savings effectively. Amundi will adapt its diversified range of SRI-labelled funds with the objective of keeping one of the broadest and most comprehensive offerings on the market.”

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