The European Securities and Markets Authority (ESMA) published the paper Consultation On Guidelines on funds' names using ESG or sustainability-related terms on 18 November 2022, proposing binding rules on the use of ESG- and sustainability-related terms in investment fund names. ESMA is taking comments on this proposal and expects to issue the final Guidelines before the end of 2023.
This paper is part of ESMA’s initiative to safeguard against “greenwashing.” Investor interest in funds with sustainability and ESG at their heart has steadily increased in recent years, and its growth likely will continue. Meanwhile, growing interest in sustainability and ESG has triggered regulator concerns about greenwashing, which is particularly driven by the misleading naming of funds.
A fund’s name is one of its most effective marketing tools, according to ESMA, which references July 2022 data saying that 14% of EU-domiciled funds have at least one ESG-related term in their name. Although ESMA recommends that investors should not base investment decisions solely the name of a fund, ultimately the fund’s name still has significant influence. It is often the first information that investors learn about a fund and contains information that can provoke a decisive first impression.
ESMA’s consultation paper marks a new phase in its anti-greenwashing initiative. Its aim is to create guidelines for the use of fund names that use sustainability- or ESG-related terms. The guidelines will apply to Undertakings for Collective Investment in Transferable Securities management companies and alternative investment fund managers when they use ESG- or sustainability-related terms in their names, including when these funds are set up as European venture capital funds, European social entrepreneurship funds and European long-term investment funds to facilitate marketing of funds throughout EU member states.
The proposed guidelines are intended to create a minimum level of commitment by funds to demonstrate and pursue ESG and sustainability goals as part of their actual investment policy and objectives, if they want to include ESG- and sustainability-related terms in a fund’s name.
With this in mind, funds must be able to show that they have met certain quantitative thresholds in order to retain sustainability and ESG-related terms in their names. To that end, the fund’s name should present a clear, fair and unambiguous marketing communication.
Suggestions for such thresholds include:
80% minimum proportion
If a fund has any ESG-related terms in its name, a minimum proportion of 80% of its investments should be used to meet ESG- or sustainable investment objectives in accordance with the binding elements of its investment strategy, as disclosed under the Sustainable Finance Disclosure Regulation (SFDR).
50% additional minimum threshold for sustainability-related terms
An additional threshold applies if a fund uses the term “sustainable” or any other term derived from it in its name. Within the 80% threshold above, it should allocate at least 50% of its funds to “sustainable investments” as defined by Article 2 (17) of SFDR.
Minimum safeguards, including exclusion criteria as set out in Article 12(1)-(2) of the Benchmark Regulation Delegated Regulation (EU) 2020/1818, are recommended for all investment funds using a sustainability- or ESG-related term in their names.
If a fund designates an index as a reference benchmark, ESMA seeks views on requiring the proposed 80% and 50% thresholds to be met by the fund before it can use sustainability- or ESG-related terms in its name.
The term ““impact” or any impact-related term in a funds’ name should only be used if the fund meets the proposed 80% and 50% quantitative thresholds above. Additionally, the investments under these minimum thresholds need to be made with the intention to spread a positive and measurable social and environmental impact.
As possible terms that could be classified as ESG-related, ESMA mentions “sustainable”, “impact”, “climate change”, “water” (in combination with “sustainable”), “biodiversity” and “society” (in combination with “sustainable”), among others. The annexes of ESMA's consultation paper provides examples of how the established criteria would ultimately be applied in practice.
Link to other regulations
It is envisaged that the proposed guidelines will not conflict with SDFR requirements or the EU taxonomy for sustainable activities; nevertheless, affected entities should verify that disclosures of asset allocation in their pre-contractual and periodic disclosures made in accordance with the SFDR are aligned with the applicable quantitative threshold.
Furthermore, in its consultation paper, ESMA refers to solutions proposed by other regulatory authorities. regulatory initiatives have been launched by the U.S. Securities and Exchange Commission, the UK Financial Conduct Authority, and by other European countries. These draft plans have farther-reaching measures with regard to fund names in some ways. Funds that use sustainability- or ESG-related terms in their names should look at all of these rules also, to discover variations among the jurisdictions and arrange compliance accordingly.
Public comment and expected feedback
First and foremost, ESMA is seeking stakeholders' views and suggestions on the proposed standards in the consultation paper. Suggestions can be made as to how the threshold mechanism could be designed differently and perhaps even better in order to effectively ensure that fund names with an ESG- or sustainability-related reference actually reflect the corresponding investment policy.
In addition, ESMA is interested in survey responses to other questions, such as whether derivatives should be subject to specific provisions for calculating the threshold. ESMA is also asking for views on whether the proposed rules should make specific provision for transitional or transition-related names.
Lastly, ESMA is asking whether and to what extent its proposals could also affect other sectors and whether similar guidelines should also be planned for other financial products.
ESMA's consultation is scheduled to run until 20 February 2023. Subsequently, the draft will be finalised and published on ESMA's website. As a result, the final version is expected to come into force a further three months later, so in Q2/Q3 2023. For funds that have ESG-related terms in their names and were launched before the publication date, a transition period of six months shall apply. After this period, affected funds will either have to redesign their investments to meet the thresholds … or change the names of their funds.
Client Alert 2023-010