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Barclays Sees $30 Billion Selloff Risk Amid New EU ESG Fund Rule

The Esso refinery, operated by Exxon Mobil Corp., right, beyond sports fields and housing, in the industrial and port area of Fos-sur-Mer, France, on Monday, Jan. 6, 2023. The European Union on Sunday ratcheted up its sanctions against President Vladimir Putin's regime, putting in place a long-planned ban on seaborne imports of Russian fuels. (Jeremy Suykur/Bloomberg)

(Bloomberg) -- Asset managers offering ESG funds in Europe may need to offload close to $30 billion in stocks and bonds if they intend to hold onto the label under new rules, according to research by analysts at Barclays Plc.

“We do expect most managers to choose to retain their name, and therefore sell excluded holdings,” Barclays analysts led by Charlotte Edwards said in a note on Thursday. That’s “particularly on the active side, as these funds are typically marketed with a sustainable name in order to attract a certain group of investors.”

The assessment follows the enforcement in the European Union of new fund naming rules designed to crack down on environmental, social and governance investing claims after repeated evidence of greenwashing. Among stocks facing the biggest hit are TotalEnergies SE, Costco Wholesale Corp., Exxon Mobil Corp. and Shell Plc, Barclays said. 

Other studies have arrived at similar conclusions. Morningstar Sustainalytics said last month it sees aggregate divestments potentially reaching $40 billion, due to the EU’s new ESG fund naming rule. Close to 6,500 EU-domiciled funds currently have ESG and sustainability-related terms in their names, according to a May report specifying the requirements set by the European Securities and Markets Authority.

Roughly three out of four equity and fixed income funds hold at least one security that breaches the new rules, so “if all funds were to sell exposure, rather than removing ESG-terms from their fund name, this would result in $24.5 billion of selling pressure from equity funds and $4.8 billion from fixed income funds,” Barclays said. 

Passive funds are more likely to change their names than active funds, the analysts said. That’s because selling a security would likely require a change to the underlying benchmark, making an exit “more challenging.” The Barclays analysts looked at 1,700 equity funds and 800 fixed income funds with a combined $1.34 trillion in assets under management.

Under the new ESMA rules, investment funds with ESG or equivalent terms will need to have at least 80% of their assets under management in something that’s actually related to the label. What’s more, funds won’t be permitted to invest in companies that are on an exclusion list under the EU’s Paris-aligned benchmark rules, or the somewhat less stringent climate-transition benchmark rules.

The Barclays analysts estimate that companies that breach ESMA’s exclusion lists, using per MSCI data, constitute 2.5% and 1.5% of assets under management in equity and fixed income funds captured by the regulation, respectively.

Funds holding US and emerging market assets are more heavily exposed to the risk of a selloff than those with European holdings, particularly on the fixed income side, because of exposures to oil and gas, the analysts said. Sectors that are most likely to be hit by exclusions under the new ESMA fund rules are energy and utilities, they said.

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