Brown-to-green funds pave the way for more Article 9 disclosures

The recent launch of two Article 9 transition funds demonstrates how real estate’s understanding of the SFDR classification is evolving.

EU flags in front of European Commission building in Brussels

Late last month, manager Fidelity International announced it had launched Fidelity European Real Estate Climate Impact Fund, its first Article 9 fund under the EU’s Sustainable Finance Disclosure Regulation. The announcement accompanied news of the fund’s first investment, the acquisition of central London office building 99 Queen Victoria Street, which the manager plans to fully refurbish in line with its objective to reposition assets into “high-quality sustainable workspaces”.

“While investors can buy new assets built to higher environmental standards, the biggest scope for achieving impact lies in the buildings that exist today, most of which are expected to still be around by 2050,” said Neil Cable, Fidelity’s head of European real estate investments, in a release. The firm did not disclose details of the fundraise and declined to comment further on the fund or its SFDR classification.

As a brown-to-green real estate vehicle disclosing under Article 9, however, Fidelity’s fund is a rare breed in today’s market. Indeed, data from New Private Markets shows only eight private real estate funds classed as Article 9 have reached a final close since 2018, raising $3.1 billion in aggregate. In comparison, 34 Article 8 real estate funds closed over the same period, raising $25.3 billion between them.

A key reason for the dearth of Article 9 real estate funds is a lack of awareness among managers that it is even possible to disclose under Article 9 if pursuing a transition strategy. “Most market participants think it’s really hard to argue that brown-to-green equals Article 9 at the outset, because of the wording of the regulation and the focus on investing into a sustainable investment,” says Tim Dolan, partner at law firm Greenberg Traurig.

Less than a year ago, INREV, the European Association for Investors in Non-Listed Real Estate, published a whitepaper entitled Falling through the cracks: SFDR’s impact on real estate investment. It highlighted multiple shortcomings of the regulation when applied to the real estate investment class. Principal among them was the requirement for funds disclosing as Article 9 to invest only in assets that are aligned with the SFDR’s definition of ‘sustainable’, with this obligation in place throughout the life of the fund. As such, it was understood that vehicles could not disclose under Article 9 if transitioning assets formed any part of their strategy.

However, the most recent guidance on the matter issued by INREV in September explained how the existing Article 9 framework does in fact allow for transition funds to disclose. This followed a consultation paper published by the European Supervisory Authorities in April, which clarified that for products with greenhouse gas emissions reduction as an investment objective, tracking a benchmark aligned to the Paris Agreement is already sufficient to meet Article 9 disclosure requirements.

“Until now, the general market view has been that it’s very difficult to be an Article 9 if you’re a brown-to-green fund,” says Dolan.

That is not to say the industry is now clear on the legislation, however. As recently as 19 October, the Association of Real Estate Funds published guidance stating that transitioning assets cannot currently be classified as sustainable investments, “which means that real estate funds dedicated to delivering a brown-to-green strategy are excluded from the Article 8+ and Article 9 universe”. Article 8+ is a classification some managers have begun labeling their funds to indicate those vehicles are ‘greener’ than Article 8 by including a minimum commitment to making sustainable investments.

‘Safety in numbers’

One of the other Article 9 real estate funds currently raising capital is Ardian Real Estate Europe Fund III from Paris-based manager Ardian. The firm is understood to be targeting €1.2 billion to acquire and upgrade office and mixed-use assets following a carbon reduction strategy, and reached a first close for the fund in October, as reported by affiliate title PERE.

According to Stéphanie Bensimon, Ardian’s head of real estate, the team spent the past two years working with lawyers and regulators on the Article 9 classification – the first in the firm’s real estate series.

“We spent a lot of time collecting the necessary data, building our resources internally as well as externally and getting a proper process in place,” she told PERE. “It takes a lot of time to go through all the details because it’s very technical and very process oriented. I can understand that if you’re a fund manager without all the necessary infrastructure for that, it may be hard to pursue an Article 9 classification.”

The decision to disclose under the most detailed of the SFDR’s sustainability frameworks should not be taken lightly, she added. “It has to be within your investment DNA. If as a value-add fund you decide to be Article 9, you must dedicate your investment strategy to transforming and decarbonising assets, which is not something all value-add funds do. We believe it’s our fiduciary duty to do so, as this focused and selective strategy maximises returns for investors.”

As Dolan points out, there is no disadvantage to being an Article 8 fund over an Article 9 fund, however. For many managers, disclosing as Article 8 is therefore simply an easier route to take.

In addition, with Article 9 requiring more detailed disclosures than Article 8, it also carries greater risk of reputational damage. “I think the legislation has left scope to reach the conclusion that a brown-to-green fund could be Article 9,” says Steven Cowins, co-chair of Greenberg Traurig’s global real estate funds practice. “But, commercially, people have reached a conclusion in the market that it’s much safer from a greenwashing perspective to opt for Article 8.”

As more well-known, reputable firms establish Article 9 brown-to-green funds, however, “people will inevitably reach a different judgement call on that reputational risk”, he says, adding there is “safety in numbers”.

With no meaningful enforcement action yet seen in Europe over a misclassification under SFDR, any fallout from the initial confusion surrounding Article 8 and Article 9 requirements could take several years to manifest in real estate markets. But the recent moves made by Fidelity and Ardian “will inevitably give other managers more confidence in going for Article 9 with similar strategies”, says Cowins.

In the meantime, more clarity on the SFDR is still required, particularly where investors are concerned. “We haven’t communicated largely on Article 9, frankly, because we know it’s an evolving classification that is sometimes unclear,” says Bensimon, adding that Ardian is educating its investors on the matter where necessary.

“Our investors are very open to understanding how we do it and how we improve our process on a day-to-day basis because this is a new and fluid topic, even though we’ve been working on it for many years.”