(Bloomberg) -- Investors will struggle to find top-ranked ESG funds after Christmas, as asset managers shy away from Europe’s strictest sustainability tag in response to tougher regulations, according to an analysis by Jefferies International Ltd.

BlackRock Inc., Pacific Investment Management Co. and Amundi SA are among firms that have already said they’re removing the EU’s highest environmental, social and governance fund designation, known as Article 9, from large chunks of their business. A Bloomberg tally indicates that funds worth at least $100 billion have been downgraded, though the actual figure may be significantly higher.

With the development set to continue, the number of new Article 9 funds being issued “will be close to zero” in the new year, Luke Sussams, head of ESG and sustainable finance for Europe at Jefferies, told Bloomberg Monday. 

Article 9 downgrades now make up 87% of all product reclassifications in the EU asset management industry, based on prospectus changes as of Nov. 22, according to a Jefferies note to clients. Morningstar Inc. estimated in mid-September that such funds accounted for roughly $470 billion of assets under management.

Fund managers have blamed regulatory guidance after the European Union clarified existing rules to state that Article 9 funds must hold 100% sustainable investments -- except for hedging and liquidity requirements. But investors want more answers. Better Finance, which represents roughly four million financial-services users, has turned to the European Commission and the European Securities and Markets Authority to seek assurances that client savings aren’t being exposed to greenwashing.

For asset managers, Europe’s regulatory landscape is likely to get more difficult to navigate next year. Beginning in January, the industry will have to provide more information than previously required on ESG products offered, including what proportion is in sustainable investments and what adverse impacts these are likely to have. 

Europe implemented its groundbreaking ESG rulebook -- the Sustainable Finance Disclosure Regulation -- in March 2021. Intended as a global gold standard, SFDR has transformed the asset management industry by setting the world’s most ambitious green goals. But it’s also faced an increasing drumbeat of criticism from investors and regulators alike for being fiendishly complex and not always consistent. 

The European Commission has said it’s aware of a number of the issues raised and is looking into the matter.

Failure to correctly categorize a fund product can lead to regulatory action against an asset manager. European authorities are already considering new minimum requirements after concluding that investors may already be subject to inflated ESG claims.

At the same time, the growing scarcity of Article 9 funds is going to make them increasingly coveted products, according to Charles Boakye, an ESG analyst at Jefferies. Flow data shows “the end asset owner would appear to have a higher preference for Article 9,” he said. “Given the difficulty in bringing such products to market,” it’s likely that investors are going to “keep demand for Article 9 products high.”

In future, the designation will probably be limited to “thematic and impact-oriented funds investing in companies that focus on sustainable products and services,” which often tend to be small- or mid-caps, or to “bond funds whose proceeds help finance green and social projects,” according to Hortense Bioy, Morningstar’s global director of sustainability research. 

Sussams said he doesn’t expect fund downgrades to undermine investor confidence, given the newness and the scale of the regulatory challenge.

“This is the market figuring out new, highly disruptive, regulation,” he said.

(Adds detail on downgrades in fourth paragraph, prediction around demand in fourth-to-last paragraph)

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