Introduction
Responsible investing is at a critical crossroads. The European Securities and Markets Authority (ESMA) recently revealed that over 40% of ESG-labeled investment funds in the EU may need to change names or sell assets to comply with new anti-greenwashing rules.
Thousands of ESG-labeled funds are still invested in companies exceeding fossil fuel revenue thresholds. At the same time, hundreds more are exposed to controversial weapons, tobacco, and businesses that harm the world.
These findings underscore the urgent need for precisely classifying green financial products. Financial institutions risk losing investor trust, facing regulatory penalties, and failing to contribute to real sustainability progress without standardized criteria. Proper classification ensures that green-labeled funds align with ESG objectives, reinforcing credibility and investment transparency.
One of the most widely adopted frameworks for green classification is the EU Sustainable Finance Disclosure Regulation (SFDR), which categorizes funds into Article 6 (no sustainability focus), Article 8 (promoting ESG characteristics), and Article 9 (targeting measurable sustainability impact). Beyond classification, the rise of transition finance offers a new investment opportunity by supporting companies actively shifting toward greener business models rather than focusing only on already sustainable ones.
Regulation as a driver
Regulatory compliance and transparency are central to classifying green financial products. The SFDR framework requires asset managers to disclose how sustainability risks are integrated into investment decisions. Without a transparent classification system, the market risks become fragmented, with inconsistent sustainability claims leading to investor confusion and regulatory scrutiny.
Beyond regulatory obligations, investor trust is at stake. Institutional and retail investors increasingly demand sustainable investment options with genuine ESG commitments. Misclassified funds that fail to meet these expectations can suffer reputational damage and potential legal consequences. Asset managers can reinforce credibility and attract responsible investors by ensuring that funds marketed as sustainable adhere to measurable ESG criteria.
Risk management also plays a crucial role in green product classification. The SFDR mandates that asset managers consider Principal Adverse Impact (PAI) indicators, which measure whether a fund’s investments cause significant harm to society or the environment. Under these guidelines, Article 8 funds must ensure that their investee companies avoid major ESG controversies, such as involvement in fossil fuels, weapons, or human rights violations, while maintaining a minimum ESG score. Article 9 funds face even stricter requirements, ensuring that at least half of their portfolio actively contributes to sustainability goals while doing no significant harm.
Studies have found that nearly half of ESG funds in the EU fail to meet Paris-Aligned Benchmark (PAB) exclusion criteria, with fossil fuel investments being the most common issue. Thousands of funds continue to invest in companies exceeding the 10% oil revenue limit, while hundreds of others are exposed to controversial weapons, tobacco, and high-emission energy generation. Financial institutions may unknowingly expose themselves to sustainability risks and non-compliance without proper classification.
Greenwashing Mitigation
Greenwashing—where financial products misrepresent their ESG credentials—has emerged as one of the most significant threats to sustainable finance—asset managers who fail to back up sustainability claims with evidence risk regulatory scrutiny and damage investor confidence. Superficial ESG integration, misleading marketing claims, and a compliance-driven “box-ticking” approach undermine the industry’s credibility and can lead to regulatory penalties.
Asset managers must adopt an evidence-based approach to sustainability classification to mitigate these risks. This requires going beyond basic ESG disclosures and conducting in-depth assessments of investee companies. A key aspect of this due diligence involves analyzing capital expenditures (CAPEX) and operational expenditures (OPEX) to determine whether companies genuinely invest in green initiatives rather than making superficial sustainability claims.
Ongoing monitoring is also critical in preventing greenwashing. A company that meets sustainability criteria today may not maintain those standards in the future. Regular reviews of investee companies ensure that funds remain aligned with their stated ESG objectives and do not become vulnerable to sustainability downgrades or reputational risks.
Stakeholder engagement further reinforces credibility in sustainable investing. Asset managers should actively engage with investee companies to ensure that they are not merely making sustainability commitments on paper but are taking concrete steps toward measurable improvements. This engagement can include setting specific ESG performance targets, participating in ESG-related shareholder resolutions, and collaborating with companies to refine sustainability strategies. Without active engagement, ESG commitments risk becoming empty promises rather than catalysts for real change.
Turning Transition into Profits
Traditional green investing has primarily focused on companies that already meet high ESG standards. However, transition finance presents a new opportunity by supporting businesses actively shifting toward greener practices. Many industries—particularly those in high-emission sectors such as energy and manufacturing—are undergoing significant transformations to align with sustainability goals. Instead of divesting from these industries altogether, asset managers can support and accelerate their transition.
Evaluating a company’s transition readiness requires a deeper level of analysis. Assessing where a company stands today is not enough; what matters is whether it has a credible plan to become more sustainable. This includes tracking science-based targets for carbon reduction, commitments to net-zero pathways, and improvements in PAI indicators over time.
For example, a European steel manufacturer, traditionally reliant on coal, has committed to net-zero emissions by 2040. Over the past three years, it has reallocated 30% of its CAPEX toward green hydrogen technology. Asset managers tracking CAPEX and OPEX shifts can verify real progress and differentiate between genuine transition leaders and companies making empty sustainability claims.
By incorporating finance into their sustainability strategies, banks, and asset managers can generate long-term value while driving real environmental and social progress. This approach expands the pool of investment opportunities beyond companies already ESG leaders, allowing financial institutions to play a more active role in shaping the sustainability landscape.
Safeguarding Banks & Asset Managers Against Unintended Greenwashing
Companies such as BlueOnion specialize in detecting greenwashing risks and monitoring transition investments using an advanced data intelligence platform.
Banks and asset managers can validate a fund’s alignment against Article 8 and Article 9 metrics through an evidence-based SFDR classification methodology. The fund’s PAI scores also ensure that funds avoid significant ESG risks and meet sustainability criteria.
For asset managers financing transition trends, demonstrating that portfolio companies are making measurable, sustainable progress is crucial. Analyzing CAPEX, OPEX, and sustainability-linked revenues offers concrete evidence of a company’s transition strategy. This approach strengthens the verification process and fosters active engagement with underperforming investees, enabling asset managers to encourage ESG improvements instead of resorting to premature divestment.
The Best of Both Worlds:
As regulatory scrutiny of ESG investing intensifies, financial institutions face the dual challenge of ensuring compliance with evidence-based standards while maintaining investor trust and mitigating greenwashing risks. Yet, effective ESG classification goes beyond regulatory obligations—it unlocks opportunities in transition finance to support companies genuinely striving for sustainability.
Advanced ESG intelligence tools help asset managers address the challenges of regulatory compliance and sustainability integration. By utilizing real-time analytics, comprehensive ESG insights, and compliance support, these tools enable financial institutions to develop transparent, sustainable investment portfolios while contributing to long-term positive impacts across the financial sector.