Many authors have documented wide discrepancies in the consistency and quality of ESG information available to investors (see e.g. (Berg et al., 2022)). Amid these debates, regulators have increasingly focused on the issue of ESG disclosure. In recent work, we examine how mandatory Environmental, Social and Governance (ESG) disclosure regulations for mutual funds influence the asset allocation of funds and investors (Emiris et al., 2025). In a model of ESG investing with uncertainty, we show that increased disclosure by mutual funds affects the portfolio of investors through two channels:
- Uncertainty Channel: Investors value the lower uncertainty about fund greenness.
- Greenness Channel: Funds respond to disclosure rules by adjusting their greenness to attract flows.
We use new data on securities holdings in Europe to test these channels, focusing on the introduction of ESG disclosure rules for mutual funds. We find that the new disclosure rules led to strong inflows into funds categorized as green. We find empirical support for both channels: green funds for which investors had little information before the regulation experience the strongest flows, and green funds that had a low ESG rating before the regulation decrease their emissions most under the new rules.
Modeling ESG Disclosure
We first develop a model to understand how ESG disclosure shapes investor portfolio choice and fund manager behavior. In the model, investors value both financial returns and the environmental performance of their investments (as in P´astor et al. (2021)). However, the greenness of the fund is uncertain (as in Avramov et al. (2022)). ESG disclosure rules reduce this uncertainty, prompting investors with strong environmental preferences to shift capital toward greener funds. The reduction in uncertainty makes flows more sensitive to fund greenness, which in turn incentivizes managers to improve their funds’ environmental performance. The model predicts that, following the introduction of a disclosure rule, inflows should be higher for funds whose (a) greenness was more uncertain and (b) environmental performance improved.
Institutional Background
We test these predictions using the case of the European Sustainable Finance Disclosure Regulation (SFDR). The regulation, introduced in 2021, requires mutual funds to choose between a ‘brown’ (Article 6), a ‘light green’ (Article 8) or a ‘dark green’ (Article 9) category, where greener categories are subject to stricter reporting requirements. The SFDR applies to all regulated funds in the European Union (EU), a market representing more than e9 trillion of assets, equivalent to more than 50% of the EU’s GDP. More than 46% of funds by assets chose to categorize themselves as green funds (Article 8 or 9) at the launch of the regulation. In the following quarters, green funds experienced positive flows representing 10.2% of their assets versus a growth of 1.9% for brown (article 6) funds. Figure 1 plots the holdings of each category of fund over time.
Empirical Findings
For each mutual fund, our data includes the shares owned by investors at the level of country (24 European countries) and sector (6 financial sectors such as banks or households). To test the two transmission channels, we leverage data on the ESG rating of funds provided by Morningstar before the regulation. We focus on two specific categories of funds. The first are those that did not have an ESG rating and chose the green category (and thus had to disclose more). These funds arguably experienced the largest uncertainty shock. The second are funds that had a low ESG rating before the regulation and chose to disclose more. We show that these funds increased their ESG rating after the regulation, thus allowing to proxy for the greenness channel. The granularity of our data, and the variation across investors, allow us to control for a broader set of fund characteristics than earlier work (e.g. (Hartzmark and Sussman, 2019)), by including fund fixed in the most stringent specifications. Consistent with the model, we find that:
- Overall Effect: Funds categorized as green (Article 8 and 9) experienced higher inflows.
- Uncertainty Channel: Funds with higher pre-regulation uncertainty about their greenness attracted
larger inflows. In the data, these are funds that did not have a Morningstar Globe Rating prior to the
regulation. - Greenness Channel: Funds that were categorized as brown prior to the regulation and subsequently
chose to become green experienced larger inflows.
Conclusion
We show that, by reducing uncertainty about fund greenness, the SFDR affected both investor and fund portfolio allocation. By mandating transparency, regulators can enable investors to make portfolio decisions aligned with their environmental preferences. Moreover, by enabling investors to more accurately observe ESG performance, disclosure increases pressure on funds to become greener. Our work opens a number of fruitful avenues for future research, such as studying whether the sectoral allocation of fund portfolios changed with the reform and whether the reallocation of investment ultimately affects the real economy.