Environment

Tightening Trends in ESG Investment Toward a Decarbonized Society

2023.1.31

As public interest in climate change mitigation continues to grow, Europe, which has been at the forefront of ESG investing, implemented the Sustainable Finance Disclosure Regulation (SFDR) in 2021, clarifying the categorization of financial products related to ESG investment. Stringent targets have been set, including those related to greenhouse gas (GHG) emissions, and the importance of quantitative, science-based analysis and reporting in corporate ESG activities is increasing.

Table of Contents

1 Growing Momentum Around Net Zero
2 Tightening Trends in the ESG Investment Environment
3 Differences Between Article 8 and Article 9 Funds Under SFDR
4 Future Outlook Based on the EU’s Sustainable Finance Policies
5 How Companies Working to Reduce Environmental Impact Can Be Better Evaluated

Growing Momentum Around Net Zero

In recent years, opportunities to hear the term Net Zero have increased significantly. Net Zero refers to a situation in which the amount of greenhouse gases emitted into the atmosphere is balanced by the amount removed from the atmosphere (*1). In order to achieve the globally shared goal established under the Paris Agreement of “limiting the rise in global temperatures to within 1.5°C compared to pre-industrial levels,” a target has been set to bring carbon emissions to Net Zero by 2050.

Confirmation of progress toward Net Zero targets has been discussed repeatedly at COP (the Conference of the Parties to the UN Framework Convention on Climate Change), an international conference where climate change measures are negotiated. At COP26 in 2021, while the United States and EU countries aimed for Net Zero by 2050, China stated that it would pursue carbon neutrality by 2060, and India declared that it would reduce emissions to Net Zero by 2070 (*2).

Because India had previously firmly refused to set a deadline for its reduction targets prior to COP26, the 2070 deadline is later than that of other countries, but it can be considered a major first step. At the same time, Prime Minister Modi attached the condition that at least USD 1 trillion in financing from developed countries to developing countries would be necessary, and India asserted its long-standing position that “developed countries bear the primary responsibility for global warming to date, and the burden of climate action, including emissions reductions, must first be borne by developed countries” (*3). India also strongly emphasized the issue of climate finance at COP29 (*4).

Discussions regarding burden-sharing among countries have recently been raised as a major agenda item. At COP15 in Copenhagen in 2009, a goal was set to increase financial support from developed countries to developing countries to USD 100 billion per year by 2020. At COP26, the fact that this goal had not been achieved by 2020 was taken up as an agenda item, and it was decided to continue further efforts to achieve this goal toward 2025 (*5). However, under the Paris Agreement adopted at COP21 in 2015, Parties agreed to extend this goal through 2025 and to set a new collective finance goal for the period after 2025 (*6). According to a report released by the Organization for Economic Cooperation and Development (OECD) in May 2024, climate finance provided and mobilized by developed countries for developing countries exceeded USD 100 billion for the first time in 2022. (That said, there are discussions about the quality of climate finance, such as the fact that 80% of total climate finance is public finance and that loans account for a large share of that public finance (*7).)

At COP29, which was also called the “Finance COP,” the conference was extended by two days because opinions from both developed and developing countries were in conflict, and an agreement was ultimately announced as the “Baku Finance Goal.” Under this agreement, a target was set for climate finance for developing countries of at least USD 300 billion per year by 2035, led by developed countries. In addition, cooperation was requested to increase total public and private finance to at least USD 1.3 trillion per year by 2035 (*8).

At COP27, the “Sharm El-Sheikh Implementation Plan” was adopted, and climate finance was discussed within it. The agenda item on financial measures related to “Loss and Damage,” which refers to losses and damages associated with the adverse effects of climate change, was added as a new agenda item in response to strong demands from developing countries. Because the gap between developed and developing countries was large, the issue was brought to ministerial-level discussions. As a result, it was decided to take new financial measures to support Loss and Damage for particularly vulnerable countries, and as part of that effort, to establish a Loss and Damage fund (provisional name) (*9). In addition, the “Sharm El-Sheikh Implementation Plan” established a “Mitigation Work Programme” to urgently scale up mitigation ambition and implementation through 2030. This programme reaffirmed the importance of 1.5°C and decided to cover all sectors as well as cross-cutting issues. At COP28, the Fund for responding to Loss and Damage (FRLD) began operations as an entity entrusted with managing the Convention’s financial mechanism.

Tightening Trends in the ESG Investment Environment

As confirmed at COP27, countries have an obligation to continue developing feasible plans to meet reduction targets and to report on them, and therefore governments are required to take appropriate actions toward implementation. In parallel with these developments, changes are also occurring in the field of ESG investment.

ESG investing spread following the United Nations’ introduction of the Principles for Responsible Investment (PRI) in 2006. As of March 2024, more than 5,300 institutions have endorsed and signed the PRI.

As ESG investment expands, the environment surrounding ESG investing is also beginning to change. Now that numerical targets are set at COP each year, companies are increasingly expected to conduct their business activities in a way that enables Net Zero to be achieved by 2050.

One example that reflects these environmental changes is the emergence of SFDR.

Differences Between Article 8 and Article 9 Funds Under SFDR

The Sustainable Finance Disclosure Regulation (SFDR) imposes ESG disclosure obligations on asset management companies and other financial market participants, and its key provisions have been in effect since March 10, 2021 (*11). SFDR’s requirements are divided into entity-level disclosure requirements set out in Articles 3 to 5, and financial product-level disclosure requirements set out in Articles 6 to 9 (*12).

In line with SFDR’s classification, funds are categorized as Article 6, Article 8, or Article 9 funds depending on their characteristics and level of sustainability (*13):

Article 6: Other funds that do not fall under the two categories below

Article 8: Funds that promote environmental and or social characteristics (light green)

Article 9: Funds that have sustainable investment as their objective (dark green)

Article 6 requires asset managers to disclose the integration of sustainability risks, regardless of whether the fund is marketed as ESG. However, when selling a product as having ESG characteristics, or when placing sustainability at the core of the investment objective, Article 6 alone is not sufficient, and the product must meet the disclosure requirements under Article 8 or Article 9.

Article 8 funds do not have sustainable investment as their objective, but they place at the core of the managed portfolio investments that, as a result, promote E or S within ESG, and they are also referred to as “light green funds” (*10). A wide range of financial products that incorporate ESG approaches, such as negative screening, positive screening, ESG integration, and thematic investing, fall under this category (*14)(*15).

In contrast, financial products classified under Article 9 are also referred to as “dark green funds” and include products whose objective is sustainable investment, such as impact investing. For Article 9 funds, SFDR sets higher-level requirements. While investee companies conduct economic activities that contribute to environmental or social objectives, they must also comply with the “Do No Significant Harm (DNSH)” principle and follow sound governance practices (*16)(*17).

With Article 9 funds becoming popular among investors, asset managers are seeking Article 9 designation, but not all funds can obtain and maintain this designation.

ESG regulations in the EU have been updated one after another, and the standards for being recognized as an Article 9 fund are becoming increasingly stringent. In November 2022, the European Securities and Markets Authority (ESMA) published guidelines defining minimum criteria to ensure that when fund names use terms such as “ESG,” “sustainable,” or “environment,” the name does not mislead investors about the fund’s investments, and it invited feedback. After updates, the final version of the guidelines on fund names using ESG or sustainability-related terms was published in May 2024. The guidelines began to apply from November 2024, and after a transition period, they were fully implemented in May 2025 (*18)(*19).

Representative examples of specific requirements set out in the guidelines include the following (*20):

When using any term covered by the guidelines (terms related to transition, social, governance, environment, impact, and sustainability), at least 80% of investments must be used to attain environmental and or social characteristics or sustainable investment objectives.

In addition to the above, different investment restrictions apply depending on the terms used, as follows.

Terms related to “environment” and “impact”: Apply the exclusion criteria of the EU Paris-Aligned Benchmark (PAB).

Terms related to “impact”: Investments must be made with the intention of generating measurable social or environmental impact alongside financial returns.

“Sustainability” related terms: Apply the exclusion criteria of the EU Paris-Aligned Benchmark (PAB) and make investments that are meaningful in relation to “sustainable investment” as defined under SFDR (initially in 2022 there were attempts to set numerical targets, but after criticism, numerical targets were not set).

“Transition,” “social,” and “governance” related terms: Apply the exclusion criteria of the Climate Transition Benchmark (CTB).

In response to these changes in standards, downgrades occurred in December 2022. Some have pointed out that downgrades from Article 9 funds also raise issues regarding how to treat Article 8 funds, which have expanded to a larger asset scale than Article 9 funds (*21). Because funds were reclassified from Article 9 to Article 8, completely different types of funds have been grouped into Article 8, and even among Article 8 funds, objectives and the level of material ESG issues vary. As a result, it is said to have become more difficult for clients to understand what they are actually receiving through Article 8 products.

Article 8 funds have a total scale of approximately USD 4 trillion, but the EU’s fund classification requirements remain ambiguous, and for Article 8, they require only the “promotion” of sustainability. The asset management industry has growing frustration with this ambiguity, and further clarification through more explicit rules is expected in the future.

Future Outlook Based on the EU’s Sustainable Finance Policies

As noted earlier, to be classified as an Article 9 fund, a fund is required to be 100% of sustainable assets, excluding hedging and liquidity-related holdings.

At the same time, the definition of “sustainable assets” remains unclear. SFDR describes sustainable assets as “investment in an economic activity with the objective of contributing to the promotion of ‘E’ (environment) or ‘S’ (social) within ESG (a sustainable investment objective), which does not significantly harm other sustainable investment objectives (DNSH: Do No Significant Harm), and where the investee company practices good practices related to ‘G’ (governance)” (*22). However, the presentation of a clearer definition remains on hold (*23).

In response, the European Supervisory Authorities (ESA) have asked the European Commission (EC) whether passive investment strategy products that designate the Paris Agreement benchmark as a reference benchmark should be automatically considered to meet the conditions of Article 9 under SFDR, but the EC has not provided a clear answer (*24).

Nevertheless, as a future outlook, it is expected that more science-based approaches will be adopted, such as setting benchmarks aligned with the Paris Agreement, as pointed out above.

One background factor is the sustainable finance policy promoted by the EU. Sustainable finance refers to mobilizing capital to incorporate ESG into business and investment decisions (*25). In response to recommendations in the final report of the High-Level Expert Group on Sustainable Finance (HLEG), submitted to the EC in January 2018, the EC announced the “Action Plan on Financing Sustainable Growth” in March 2018. In May 2018, it adopted a package of measures to implement the main actions set out in the plan.

There are three main measures. The first is the EU Taxonomy, a regulation on establishing a framework to promote sustainable investment. The second is the Benchmark Regulation, which sets EU standards for “Paris-aligned benchmarks” and “climate transition benchmarks” and establishes rules for sustainability-related disclosures for benchmarks. The third is SFDR, which has been discussed above.

The first measure, the EU Taxonomy, refers to establishing an EU-level framework that serves as a classification system, enabling the assessment of whether a given economic activity is sustainable based on that framework. Under the Taxonomy Regulation, in order to be defined as an environmentally sustainable economic activity, all four of the following requirements must be met (*25).

(1) Make a substantial contribution to at least one environmental objective (climate change mitigation, climate change adaptation, the sustainable use and protection of water and marine resources, the transition to a circular economy, pollution prevention and control, and the protection and restoration of biodiversity and ecosystems)

(2) Do no significant harm to any of the environmental objectives

(3) Be carried out in compliance with the following minimum social and governance safeguards

(a) OECD Guidelines for Multinational Enterprises
(b) United Nations Guiding Principles on Business and Human Rights
(c) Rights set out in the principles identified in the International Labour Organization (ILO) Declaration on Fundamental Principles and Rights at Work
(d) The International Bill of Human Rights

(4) Meet the Technical Screening Criteria (TSC) adopted in accordance with the Taxonomy Regulation

The Technical Screening Criteria that correspond to the fourth requirement are used, for each environmental objective, to determine whether the economic activity makes a substantial contribution and can therefore be considered sustainable. The main requirements include the following (*25).

They are grounded in robust scientific evidence and the precautionary principle (Article 191 of the Treaty on the Functioning of the European Union (TFEU)).

・ They are quantitative and have thresholds, and where possible, are accompanied by certification. Otherwise, they are qualitative.
・They identify the contributions most likely to be relevant to the environmental objectives.
・They include all relevant economic activities within a given economic sector.
・They are easy to use and easy to verify.
・They do not use solid fossil fuels such as coal for power generation.

The TSC are to be established through delegated acts, and until the TSC related to the relevant objectives are adopted, the taxonomy is considered not to be applicable in practice.

In the first draft delegated act published on April 21, 2021, which specified sustainable activities for the objectives of climate change mitigation and climate change adaptation, a set of TSC was introduced to define activities that make a substantial contribution to the environmental objectives in the Taxonomy Regulation related to climate change mitigation and climate change adaptation, based on scientific advice from the Technical Expert Group on Sustainable Finance (TEG).

The second measure, the Benchmark Regulation, was introduced due to concerns about the accuracy and integrity of indices used as benchmarks in financial markets. The EC planned to ensure consistency with the EU Taxonomy by the end of 2022, and Paris-aligned benchmarks and climate transition benchmarks have become commonly used benchmarks (*25).

To maintain consistency in its sustainable finance policy, the EU is expected to align the criteria under the EU Taxonomy and SFDR with this Benchmark Regulation. As a result, companies are expected to be required to measure and disclose GHG emissions related to the Paris Agreement’s objectives in a quantitative manner.

In France, from 2023 onward, there has been a move to gradually mandate environmental labeling for food that “includes climate change.” Article 2 of the Climate and Resilience Law, which entered into force in August 2021, stated the intent to “introduce a system, after implementing pilot projects, to display environmental impacts on labels for products and services, including food” (*26).

How Companies Working to Reduce Environmental Impact Can Be Better Evaluated

In this way, in Europe, which is advanced in the field of ESG investment, various rules related to ESG investment have begun to be established. In particular, these trends are expected to accelerate further in order to prevent greenwashing. The ESG-related landscape is constantly changing, and whether activities that have been valued to date will continue to be valued in the future requires continuous monitoring of trends. International interest in setting quantitative targets related to Net Zero has been growing stronger, and in the investment field as well, the importance of science-based, quantitative measurement and disclosure is increasing.

Our service My-Eco-Ruler uses internationally recognized scientific and quantitative analytical methods to quantitatively evaluate contributions to decarbonization against standards aligned with Science Based Targets (SBT) that are consistent with the level required by the Paris Agreement, which aims for global Net Zero by 2050. By evaluating initiatives across a product’s supply chain based on Life Cycle Assessment (LCA) and converting them into scores, the service helps “visualize” corporate environmental initiatives and supports the delivery of clear, easy-to-understand information to consumers.

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Companies interested in accelerating ESG management through scientific and efficient analytical approaches are welcome to contact “cuoncrop” at any time.

cuoncrop ESG Global Trend Research Division

References

*1https://www.amundi.co.jp/esg/cop26-introduction-to-net-zero.html

*2https://www.bbc.com/news/world-asia-india-59125143

*3https://www.spf.org/iina/articles/toru_ito_07.html

*4https://indianexpress.com/article/world/india-rejects-cop29-climate-finance-deal-calls-optical-illusion-9687012/

*5https://www.nies.go.jp/social/navi/colum/cop26.html

*6https://climate.ec.europa.eu/eu-action/international-action-climate-change/international-climate-finance_en　

*7https://www.oecd.org/en/about/news/press-releases/2024/05/developed-countries-materially-surpassed-their-usd-100-billion-climate-finance-commitment-in-2022-oecd.html　

*8https://www.jetro.go.jp/biz/areareports/2025/cb5be09dda2cdfd1.html　

*9https://www.mofa.go.jp/mofaj/ic/ch/page1_001420.html

*10https://www.pictet.co.jp/basics-of-asset-management/view-of-the-market/esg-investment/20210408.html