ESMA publishes guidelines on establishing harmonised criteria for use of ESG and sustainability-related terms in fund names
On 14 May 2024, the European Securities and Markets Authority ("ESMA") published its final report on "Guidelines on funds’ names using ESG or sustainability-related terms" (the "Guidelines"). The Guidelines aim to provide fund managers with clear and measurable criteria to assess their ability to use ESG and/or sustainability-related terms in fund names, thereby ensuring that investors are protected against associated greenwashing risk.
Background
The Guidelines were initially proposed by ESMA in its November 2022 consultation paper, which stated that it expected to issue the Guidelines in Q2/Q3 2023 (the "Consultation Paper"). According to ESMA, the publication of the Consultation Paper was in response to increased investor demand for ESG-focused funds, which has created incentives for fund managers to include sustainability-related terms in fund names to attract investors. Such an increase in investor demand has consequently increased the risk of greenwashing and the need to validate the sustainability-related terms used in fund names.
In December 2023, ESMA released a public statement explaining that the publication of the Guidelines had been delayed to ensure that the outcome of the reviews of the Alternative Investment Fund Managers Directive 2011 ("AIFMD") and the Undertakings for Collective Investment in Transferable Securities Directive 2009 ("UCITS Directive") could be fully considered. The Guidelines were subsequently published on 14 May 2024, following the end of the AIFMD and UCITS Directive reviews.
Key provisions of the Guidelines
(a) Transition, social and/or governance-related terms
If a fund has any transition, social and/or governance-related words in its name, a minimum proportion of at least 80% of its investments should be used to meet the environmental or social characteristics or sustainable investment objectives in accordance with the binding elements of the investment strategy, as disclosed under the EU Sustainable Finance Disclosure Regulation ("SFDR").
The Guidelines provide that ESMA will take a broad view on terms that should be seen as transition-related, which could include terms such as "progress", "transformation", "evolution" and "improving".
The Guidelines also provide that when using transition-related terms, fund managers should demonstrate that the investments are on a clear and measurable path to social or environmental transition.
(b) Environmental and/or impact-related terms
If a fund has any environmental and/or impact-related words in its name, a minimum proportion of at least 80% of its investments should be used to meet the environmental or social characteristics or sustainable investment objectives in accordance with the binding elements of the investment strategy, as disclosed under the SFDR.
The Guidelines provide that terms such as "ESG" and "SRI" should be seen as environmental terms.
The Guidelines also provide that impact-related terms should only be used by funds "whose investments are made with the intention to generate positive, measurable social and environmental impact alongside a financial return”.
(c) Sustainability-related terms
If a fund has the word “sustainable” or any other term derived from the word “sustainable” in its name, a minimum proportion of at least 80% of its investments should be used to meet the environmental or social characteristics or sustainable investment objectives in accordance with the binding elements of the investment strategy, as disclosed under the SFDR.
ESMA has not defined what investing "meaningfully" means. The Consultation Paper initially had a 50% sustainable investment requirement for funds using sustainability-related terms in their names, but this was dropped in the Guidelines following negative feedback during the consultation period. Although unclear at this stage, it is not beyond the realms of possibility that the initially proposed 50% sustainable investment requirement will be inferred as being "meaningful" in practice.
(d) Terms using a mixture of (a)-(c)
If a fund uses a mixture of the various terms referred to in (a)-(c) above, the requirements referred to above should apply cumulatively.
(e) Minimum safeguards
Minimum safeguards, including exclusion criteria for Paris-aligned Benchmarks ("PAB"), as defined in the EU Benchmark Regulation Delegated Regulation, are recommended for all investment funds using environmental, impact and/or sustainability-related terms in their name. The exclusion criteria for Climate Transition Benchmarks ("CTB"), as defined in the EU Benchmark Regulation Delegated Regulation, are recommended for all investment funds using transition, social and governance-related terms.
The Guidelines provide that where environmental terms are used in combination with transition terms, the CTB exclusions should apply, not the PAB exclusions. This is, however, not the case for sustainability terms used in combination with transition terms, where the PAB exclusions apply.
Application of the Guidelines
The Guidelines apply to SFDR-aligned financial products that are active funds, passive funds and closed-ended funds. The Guidelines do not apply to non-SFDR-aligned financial products. For more information on what SFDR-aligned financial products are, read our earlier update here.
The Guidelines provide that fund managers must make "every effort" to comply with the Guidelines and that the competent authorities of Member States are expected to ensure that fund managers comply with the Guidelines.
Next steps
The Guidelines will be translated into all EU languages and will subsequently be published on ESMA’s website. The Guidelines will start applying three months thereafter.
Within two months of the Guidelines being published on ESMA’s website, competent authorities of EU Member States must notify ESMA whether they: (i) comply with the Guidelines; (ii) do not comply with the Guidelines, but intend to comply; or (iii) do not comply and do not intend to comply with the Guidelines.
For funds existing before the Guidelines begin to apply, fund managers will be required to comply with the Guidelines within six months of the application date of the Guidelines. For funds created after the Guidelines begin to apply, fund managers will be required to comply with the Guidelines immediately.
