(Bloomberg) -- Europe’s effort to prod investors to the front lines of the climate change fight is hitting a snag: confusion over how to treat 12.4 trillion euros ($15 trillion) of central government debt, the biggest slice of the bond market.

Asset managers will have to disclose next year the extent to which their funds are invested in what the European Union considers environmentally sustainable activities. But the green list doesn’t address government services, leaving the regulators to debate whether the final disclosure requirement should exclude sovereign bonds from the outset.

The issue reflects just how much government debt there is and whether counting it would distort a fund’s green credentials. Pitting asset managers, investors and governments against each other, it’s also raising questions about the effectiveness of the disclosure measure to steer capital toward helping stave off environmental catastrophe. 

“That is an issue of credibility of the system at a time when Europe is trying to be the first jurisdiction to have some sound, robust sustainable finance rules in place,” said Victor van Hoorn, executive director of Eurosif, whose members manage around 20 trillion euros and want government bonds included.

Asset managers are due to face the new reporting requirements next July, when the final details of the Sustainable Finance Disclosure Regulation will be implemented. The most ambitious regulation of its kind globally, SFDR was designed to thwart inflated claims of do-gooding in the financial industry and to funnel investments to businesses that commit to reaching the Paris Agreement on climate change. Key elements have already been in place since March.


The CFA Institute, which sets professional standards for the asset management industry, advocates for including all investments to prevent “cherry-picking.” But Clemence Humeau, head of responsible investment coordination and governance at AXA Investment Managers, says that if an underlying asset isn’t addressed in the EU list of sustainable activities, including it “doesn’t make much sense,” any more than including cash makes sense.

“I don’t think it provides an accurate description of the actual alignment of the assets which are eligible,” Humeau said.

The European Securities and Markets Authority, which is charged with protecting investors, says it’s working to find a solution and may come with a recommendation in the next few weeks. Final approval will come from the EU commission, parliament and council. 

“We want to make sure that investors aren’t misled about the actual alignment of the investments underneath,” said Patrik Karlsson, the SFDR expert at ESMA, which surveyed financial market participants earlier this year. 

Asset Managers to Get Clarity on EU Greenwash Rules Within Weeks

The dilemma highlights the complexity of the EU’s green package and the speed at which it is being adopted as Europe, facing extraordinary floods and fires, races ahead to stem climate change and meet its commitment to keep global temperatures from rising to dangerous levels.

Some investors say governments will eventually need to be included in the list of sustainable activities or be held to something akin to it. “Political resistance” by countries worried about their carbon footprint is the reason why it hasn’t happened so far, says Alexander Lehmann, former lead economist for the European Bank for Reconstruction and development and now a non-resident fellow at the Brussels-based Bruegel think tank. 

‘Sovereign Exposure’

“A sovereign exposure is not carbon neutral, and some less so than others,” Lehmann said.

European lawmaker Pascal Canfin, who chairs parliament’s environmental committee, says now’s not the time to try and apply the sustainable-activities list to sovereigns. They need a different yardstick than the private sector to measure how green they are.

“If you start injecting the sovereign issue now, then you can get lost for years,” Canfin said. “Then you do not move things forward. You need to separate the two, to start with private assets and then once it’s consolidated, once it works, once it becomes the new normal on the market, then of course the question of the sovereigns will be put on the table, but it’s too early now.”

In the absence of a way to measure governments’ green policies, there is precedent for omitting government bonds from calculations of how green asset managers’ investment products are. 

The European Commission removed the securities, for now, from the list of investments that banks, insurers and asset managers must include when reporting how aligned their businesses are with the list of environmentally sustainable activities, thereby avoiding making big holders of government bonds look like ESG laggards. 

That’s now left ESMA grappling with what to do with the products that the financial institutions sell.

“We are on the product side still thinking about this,” Karlsson said. “We want to make sure that we calibrate disclosures appropriately.”


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