What is a negative screening?
Negative screening means excluding certain sectors, companies, or activities from an investment universe. Common examples include:
- Tobacco and alcohol.
- Weapons and defense.
- Coal or other high-emission energy sources.
- Companies with severe governance controversies.
Historically, this has been the entry point to ESG investing because it’s simple and easy to explain to investors.
Why negative screening alone is not enough for article 8
Article 8 funds must do more than exclude “bad actors.” They need to actively promote environmental or social characteristics in their investment process.
Key reasons exclusions fall short:
- Reactive, not proactive: Screening avoids harm but doesn’t promote positive characteristics.
- Limited transparency: Investors and regulators want evidence of ESG integration, not just a list of banned sectors.
- Risk of greenwashing: Marketing a fund as “ESG” based only on exclusions is increasingly seen as superficial.
- Regulatory requirement: SFDR specifically requires funds to show how ESG is embedded into due diligence, portfolio monitoring, and reporting, not just sector screens.
What article 8 funds are expected to show
To qualify as Article 8, a fund must demonstrate that ESG characteristics are part of its binding investment process. Exclusions can still be part of this, but they must be combined with positive integration. This includes:
- Defined E/S factors: Clear criteria the fund promotes (e.g., diversity, carbon footprint, supply chain ethics).
- Integration in due diligence: ESG is assessed alongside financial performance before investments are made.
- Ongoing monitoring: ESG performance of portfolio companies is tracked over time through selected KPIs. Invest Europe’s minimum list or mandatory PAI indicators can be a good starting point for data collection.
- Disclosures: The fund uses SFDR templates to show methodology, KPIs, and results.
Examples: screening vs. article 8 integration
Negative Screening Only (Not Enough)
A fund excludes coal and tobacco companies but otherwise invests based only on traditional financial metrics.
Article 8 Compliant (Screening + Integration)
A B2B SaaS fund excludes coal but also embeds ESG criteria like pay equity, cybersecurity, and tax transparency into due diligence and monitors them annually across the portfolio.
Sustainability Generalist Fund Example:
A fund investing in education, healthcare, and ethical mining promotes different ESG themes in each sector. Negative screening may apply across the board, but the fund also tracks sector-specific ESG KPIs (e.g., student access, patient outcomes, worker safety).
How to move beyond negative screening
- Define ESG Characteristics Clearly: Pick 3–5 environmental/social themes that matter for your strategy (e.g., climate resilience, workforce diversity, community impact).
- Embed Them in Due Diligence: Add ESG questions to your investment memos and screening checklists.
- Set KPIs at Portfolio Level: Choose measurable indicators you can collect annually (e.g., gender pay gap, carbon intensity).
- Disclose Transparently: Use SFDR templates and publish both methodologies and results.
- Engage Portfolio Companies: Work with founders to improve ESG practices, not just avoid problematic sectors.
Case study: what a robust exclusion policy looks like
Some funds develop comprehensive exclusion policies that go far beyond a simple “no tobacco” rule. For example:
- Behavior-based exclusions: Companies involved in corruption, money laundering, or human rights violations; those failing UN Global Compact or OECD standards; or lacking basic governance safeguards.
- Product-based exclusions: Tobacco, alcohol, pornography, controversial weapons, fossil fuels (coal, oil sands, Arctic drilling), destructive fishing, tropical logging, and certain hazardous chemicals.
- Biodiversity & protected areas: Investments linked to deforestation, endangered species trade, or harmful impacts on protected ecosystems.
- Data-related exclusions: Companies enabling illegal data exploitation or cyber intrusion.
- Values-driven criteria: In this example, even leadership representation (e.g., requiring LGBTQ+ diversity at the leadership level) is written into the exclusion list.
This shows how exclusionary screening can be very detailed and values-specific.
But even with this level of rigor, exclusions alone don’t make a fund Article 8. To qualify, managers must also promote positive environmental/social characteristics, collect annual ESG data, and publish periodic disclosures.
Why this matters for investors and LPs
- LP Trust: Exclusion-only funds risk being seen as greenwashing.
- Market Access: Many LPs require Article 8 classification as a baseline.
- Resilience: ESG integration helps reduce risks (e.g., regulatory fines, reputational damage).
- Competitive Edge: Funds that go beyond negative screening stand out in a crowded ESG market.
Negative screening is a starting point
But it’s not enough to qualify as an SFDR Article 8 fund. To comply and to compete managers must go further, embedding ESG characteristics into due diligence, portfolio monitoring, and transparent disclosures.
Next step: Explore our full guide on SFDR Article 8 Fund Requirements or contact us to draft your responsible investment policy.
