A mass wave of downgrades that shocked investors as they watched Europe’s top ESG designation get stripped from almost US$200 billion ($266.29 billion) may now be reversed.

Many of the reclassifications, which saw a coveted ESG tag known as Article 9 get wiped off EUR175 billion ($255.78 billion) in funds in late 2022, appear to have been unnecessary in light of new guidance from the European Commission, according to Hortense Bioy, global director for sustainability research at Morningstar.

The upheaval last year led investors and regulators alike to question the basic construction of the environmental, social and governance investing rulebook that Europe enforced more than two years ago. The Sustainable Finance Disclosure Regulation (SFDR), which EU officials had hoped would serve as a global standard, has undergone a series of updates since its enforcement to address a seemingly endless list of shortcomings.

The downgrades, which led BlackRock, Amundi and many others to reclassify their Article 9 funds under a weaker ESG designation known as Article 8, disproportionately affected passive strategies. The confusion set in last year as the market and even regulators struggled to interpret existing rules.

Passive funds that went from Article 9 to Article 8 because they tracked Paris-aligned benchmarks and climate-transition benchmarks now “may be required to be reclassified as Article 9,” Bioy said in an email.

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In its new guidance, published on April 14, the EU Commission said SFDR is “neutral” when it comes to financial product design, and that investments “that have an objective of reduction in carbon emissions can therefore fall within the scope” of Article 9. That applies “whether they use a passive or active investment strategy,” it said.

The EU Commission’s latest clarifications also seek to address the long-outstanding issue of how to define a sustainable investment. The EU’s failure to date to provide clear parameters around such a key ESG concept has drawn criticism amid concerns of greenwashing.

The Commission said it will not impose minimum thresholds and instead leave it to market participants to demonstrate that their claims are fair. At the same time, it warned that the disclosure framework requires “increased responsibility” on the part of market participants.

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But that could end up being costly for clients.

“For investors, the lack of explicit regulatory standards increases the time and effort required to identify financial products that both meet their sustainability preferences and protect them from greenwashing,” Stephan Kippe, an analyst at Commerzbank Research, said in a note.

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