Sustainable Development Goal Funds – New Regulations Ahead?

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By Martin Hermanns-Couturier, Head of Investment & Asset Management Practice at Praxio Law & Tax as published in Insight Out #29.

After the financial crisis of 2008, legislators and regulators have established the finance industry as a fertile ground for regulation and this tendency is not about to stop. Hence, it is a good idea to pay attention when indicators for new regulations appear on the horizon. With this in mind, it is noteworthy that on 1st February 2024 the European Securities and Markets Authority (ESMA) has published a risk analysis entitled “Impact investing – Do SDG funds fulfill their promises?”. ESMA’s analysis might indicate where the regulators see future areas of regulation and therefore, it might be useful to take a closer look at it.

Impact Investing

The analysis uses the Global Impact Investing Network’s definition of impact investing, which defines the term as: “Investing with the intention to create positive, measurable social and/or environmental impact alongside financial return.”

While there is a very optimistic drive in this definition, it unfortunately lacks precision what “positive, measurable social and/or environmental impact” actually means. However, the United Nations (UN) have considered the question what positive social and/or environmental impact might comprise and have defined 17 goals for sustainable development (the SDGs), being in short: no poverty; zero hunger; good health and well-being; quality education; gender equality; clean water and sanitation; affordable and clean energy; decent work and economic growth; industry, innovation and infrastructure; reduced inequalities; sustainable cities and communities; responsible consumption and production; climate action; life below water; life on land; peace, justice, and strong institutions; and partnerships for the goals.

ESMA’s approach

From the perspective of the ESMA, the provision of financial support to any of these goals with the aim to achieve at the same time a financial return should qualify as impact investing.

The analysis considered (a) the fund documentation of various funds claiming to pursue impact investing compared to other funds with no such claim, being either traditional investment funds or funds complying with certain environmental, social and governance (ESG) requirements, (b) the funds’ portfolios, (c) SDG alignment of the portfolios considering SDG alignment on country and corporate level and (d) the disclosures of principle adverse impacts (PAIs).

ESMA assumes that funds pursuing SDGs are funds whose investment approach considers ESG requirements. Impact investing funds are thus a specific form of ESG funds and may fall within the scope of Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability‐related disclosures in the financial services sector (SFDR), especially article 8 SFDR relating to funds that are promoting sustainability characteristics and article 9 SFDR for financial products having sustainable investment as its objective.

ESMA’s findings

For its analysis, ESMA collected data from 14,633 investment funds of which 187 were considered SDG funds. ESMA established a significant increase in launches of SDG funds over the last few years as about 44% of those funds were launched in or after 2020. The statistics established by ESMA show that the number of SDG fund launches is accelerating compared to launches of non-SDG funds.

ESMA bases its comparison between SDG- and non-SDG funds on three major criteria / pillars, (a) investments in companies which have joined the United Nations Global Compact (i.e. companies committing to the SDGs – the UNGC) compared to investments in other companies, (b) investments in sovereigns based on the UN’s SDG index score of the relevant issuing countries, and (c) investments in development bank bonds.

Investments in companies

The percentage of the portfolio that SDG funds invest in UNGC companies is not considerably different from that of non-SDG funds. Regarding the number of assets held in such companies, SDG funds mark slightly better than the others, when it comes to assets under management this role is inversed. In any case ESMA considers the differences as statistically insignificant. The analysis establishes however certain statistically relevant differences when comparing SDG funds to funds falling under articles 8 and 9. Those funds show a higher average investment rate in UNGC companies in terms of number of assets and assets under management.

For PAIs, ESMA’s risk analysis shows mixed results, too: For most SDGs, the SDG funds perform better, however with some exceptions.

Finally, ESG funds do perform better when it comes to the disclosure of assets violating the UNGC principles but their investee companies tend to do worse regarding the UNGC compliance mechanisms.

Investment in sovereigns

The analysis shows that in general SDG funds invest more in sovereign debt of countries with a higher SDG index score (74 for SDG funds vs. 64 for non-SDG funds). However, for some SDGs (notably responsible consumption and production as well as climate action) this is not the case.

Investment in development bank bonds

Finally, for investments in bonds of development banks, the result is once again mixed. While the percentage of funds holding such bonds is higher for non-SDG funds, the SDG funds actually investing in such bonds appear to invest a higher part of their assets under management into those bonds.

ESMA’s conclusions

While ESMA points out that there is an increasing offer and demand for SDG funds in the market, ESMA deducts from its findings that SDG funds are “not significantly different” from other funds. ESMA sees a relevant potential for “impact-washing”, especially considering SDG funds’ “broad scope and absence of a harmonised definition or specific requirements”.

At the same time, ESMA underlines the importance of these funds for the SDGs’ success. However, the final conclusion is that the “analysis raises investor protection concerns as the funds claiming to contribute towards the SDGs do not appear to differ significantly from other funds in their exposure to firms signalling to concretely contribute to the UN SDGs”.


ESMA’s interest to better understand the possibilities and risks of impact investment is a positive sign. Important efforts were made for this analysis and the idea to fight greenwashing and impact-washing is crucial to ensure the success of SDG funds and of the SDGs in general.

Still, some observations should be made:

1. The analysis primarily verifies the extent of SDG funds’ investments in companies having declared to pursue the SDGs. ESMA’s assumption being that the best/most efficient way to support the SDGs is by investing in such companies. The analysis does not specify the reasoning behind this assumption, especially as the hurdles for membership are low and thus the risk of greenwashing is rather high. The possibility that investments in UNGC companies might be a very limited indicator for SDG compliance is not considered. The fact that there is not much difference when investing in UNGC companies is then presented as proof that SDG funds are in principle normal funds with a risk of impact-washing.

2. As impact investing aims at supporting change over a certain period of time, SDG funds may consider to invest where the change is too slow or not yet happening, with the intention to support any positive change. ESMA’s analysis does not take into consideration the possibility of a development from a non-UNGC company to a company adhering to the SDGs. One of ESMA’s findings is that SDG funds are “holding fewer assets on average” while being “larger than non-SDG funds”. This could be an indicator that SDG funds effectively aim at a higher involvement in their portfolio companies than more traditional funds (however, other explanations are of course possible, too). If that were to be the case, SDG funds would be acting as active investors, trying to direct the management of their portfolio companies towards the SDGs. For a fair evaluation of SDG funds it would be necessary to analyse the active involvement of the funds in the SDG decisions of their investee companies. Due to the way data was collected, this could not be done in the ESMA analysis, leaving thus an important area for future research.

3. The analysis states that much of its data is pretty new with 44% of the funds under review having been established in or after 2020. The impact of such SDG funds is likely to be rather limited in such a short period. Hence, to establish the effectiveness of the SDG funds, it would be necessary to review the developments of the investee companies over a longer period of time. The analysis does not indicate if ESMA will do this and update its analysis in the future.

In conclusion, the analysis has collected and compared a considerable amount of data. However, the choice and interpretation of the data seems to be too limited to establish the chances and risks involved in SDG funds. If the idea is to draw up regulations for SDG funds in the future, ESMA’s present analysis is only a small first step in that direction and more research will be necessary to evaluate how and to what extent SDG funds effectively support the SDGs and how the necessary transparency for investors can be ensured.