On 30 June 2025, the European Securities and Markets Authority (ESMA) (finally) published its report on the integration of sustainability risks and related disclosures. The report presents the findings of ESMA’s investigation on how sustainability risks are integrated and how the current SFDR framework is being applied by the selected fund managers.
Earlier this month, ESMA also issued a public statement addressed to the financial sector, urging the use of clear, fair and non-misleading sustainability claims. The statement includes examples of both good and poor practices in the use of such claims.
This article focuses on one poor practice cited in the ESMA report, illustrated through a fictional case. The example shows how a lack of oversight on sustainability risks can, in this case, lead to misleading sustainability claims.
We outline what the fund manager should have done, and which actions are necessary to prevent recurrence.
Fund manager Ultra Asset Management (“Fund Manager Ultra”) was part of the aforementioned ESMA investigation. Through its local supervisory authority, the fund manager was notified of the investigation and requested to submit various documents, including those related to its Article 8 SFDR fund.
An Article 8 SFDR fund is a fund that promotes environmental and/or social characteristics and only invests in companies that follow good governance practices. Such funds are subject to the following transparency requirements:
In the fund’s pre-contractual disclosures (Annex II), the investment strategy is described as promoting all Sustainable Development Goals (SDGs); the seventeen goals set by the UN to end poverty, protect the planet, and ensure that all people enjoy peace and prosperity.
On its website, Fund Manager Ultra displayed icons representing all 17 SDGs next to its fund information.
However, the fund’s periodic report (Annex IV) indicated that only two SDGs were promoted as the fund’s environmental and/or social characteristics. The regulator reprimanded Fund Manager Ultra for misleading investors by initially claiming all SDGs were promoted, while the periodic report showed that only two SDGs were represented in the portfolio throughout the year.. This, the regulator argued, does not assist investors in making informed decisions regarding SDG-related investments, and merely allows the fund manager to claim retrospectively that some SDG investments were present in the portfolio.
When selecting investments for its Article 8 SFDR fund, fund manager Ultra acted in accordance with its investment policy, which promoted all SDGs as the fund's environmental and social characteristics. The fund manager applied its sustainability risk integration policy and identified greenwashing as a potential sustainability risk. However, due to its strict selection process, the manager assessed the risk of greenwashing as limited.
How could the periodic report (Annex IV) show that only two SDGs were ultimately promoted, despite the fund’s thorough investment process?
It turned out that throughout the year, the investment committee had only reviewed the financial performance of the underlying investments. Whether these investments continued to align with the fund’s promoted environmental and social characteristics (i.e. all 17 SDGs) had not been monitored.
Fund manager Ultra had not implemented any processes to monitor investments against the SDGs, even though it is the foundation of the environmental and social characteristics that are promoted by the fund. Additionally, there were no clear time limits or thresholds for determining how long investments could be held before divestment, if they were no longer aligned with the investment strategy. Also, the risk management process lacked any form of ongoing monitoring of the sustainability risks previously identified.
The case of Ultra Asset Management demonstrates that, despite a strong start and good intentions, the absence of structural monitoring and follow-up can ultimately lead to greenwashing.
The key to effective management of sustainability risks is to establish - and actively implement - all stages of the risk management process.
Had Fund Manager Ultra implemented a proper risk management process, it could have determined much earlier that the investments in the fund were no longer in line with the investment strategy. Had Fund Manager Ultra implemented a risk management framework that included ongoing monitoring of identified sustainability risks, and a link to the monitoring of the investment policy (and implemented it), it could have identified much earlier that the portfolio no longer reflected the stated investment strategy, thereby increasing the risk of greenwashing.
Fund Manager Ultra now knows what needs to be done to prevent a recurrence. But is Ultra the exception? Probably not.
Earlier this month, the Dutch Central Bank (DNB) issued a statement following a roundtable discussion with small and medium-sized pension funds on ESG risk analysis. One key topic was the presence of implicit assumptions. DNB observed that, in practice, pension funds often rely on assumptions such as:
These (incorrect) assumptions may also be found among fund managers, banks, insurers and investment firms.
Have you fully integrated sustainability risks in your organization, or do you still have questions? We are here to help. We support the development, review and implementation of robust policies, risk management frameworks, data verification and reporting processes.
