ESMA publishes final guidelines on minimum thresholds for ESG and Sustainability-related fund names

The name of a fund is the first communication opportunity on which investors become interested in a fund and it is therefore an important marketing tool. Such a name is usually the first feature investors notice and, although investors are expected to look beyond the name itself and review the fund’s documentation in detail, the name can have a significant impact on their investment decisions. 

Notwithstanding the above investors may reasonably expect funds using terms such as sustainability or sustainability related terms in their name to actual invest in companies with policies, practices, or characteristics with (some) sustainability standards. Market pressure creates incentives for asset managers to include such terminology in their funds’ names designed to attract investor assets, which could lead to greenwashing, by making false claims about the real “sustainable” assets invested in. 

Consultation on Guidelines on funds’ names using ESG or sustainability-related terms

To tackle greenwashing risk in fund names ESMA published a Consultation on Guidelines on funds’ names using ESG or sustainability-related terms on 18 November 2022 ESMA based on existing provisions in the AIFMD, UCITS Directive and the EU regulation on facilitating cross-border distribution of collective investment undertakings to set (some) boundaries for funds using such terms. 

The proposed Guidelines complement the already principle-based guidance for funds’ names with ESG and sustainability-related terms which were provided by ESMA’s May 2022 supervisory briefing on sustainability risks and disclosures in the area of investment management.

The Consultation proposed quantitative thresholds for the use of ESG and sustainability related terminology in funds’ names:

• If a fund has the word “sustainable” or any other term derived from it in its name, it should allocate within the 80% of “ESG” investments at least 50% a minimum proportion of sustainable investments as defined under the Sustainable Finance Disclosures Regulation (SFDR); 
• If a fund has any ESG-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; 
• Recommendation for minimum safeguards consisting of the exclusions criteria applicable to Paris-aligned Benchmarks in the Commission Delegated Regulation (EU) 2020/1818 (“PAB exclusions”) to support the name of the fund not being misleading.

ESMA argued that a threshold of at least 50% of sustainable investments an appropriate proxy for funds disclosing under Article 8 SFDR (that should meet the minimum proportion of 80%) are ensuring the consistency of their investments with the use of the word “sustainable” or any other sustainability-related terms in their name. The proposed figure of 50%, in conjunction with the 80% figure, is high enough to justify the use of the term sustainable or any other sustainability-related terms also in the name of fund disclosing under Article 8 SFDR, in essence a so called 8 + SFDR product. 

Public Statement

This consultation was followed by a public statement on 14 December 2023 in which ESMA introduced some amendments to this consultation. For instance, a new category for transition-related terms, a separation of “E” from “S” and “G” terms and measurability of impact and transition terms were introduced.

But surprisingly ESMA also stated that the 50% threshold could no longer be retained and introduced as a substitute: to invest “meaningfully” in SFDR-aligned “sustainable investments” (in the original proposal referred to as the 50% threshold).

Funds using the word “sustainable” or related terms in their names are recommended to meet all of the following criteria:

• At least 80% of the fund’s investments should meet the sustainability characteristics or objectives;
• Apply PAB exclusions prohibiting them from investing in companies:
  • involved in controversial weapons;
  • involved in the cultivation and production of tobacco;
  • found to be in violation of the UNGC principles or OECD Guidelines for Multinational Enterprises
  • that derive at least 1% of their revenues from exploration, mining, extraction, distribution or refining of coal;
  • that derive at least 10% of their revenues from the exploration, extraction, distribution or refining of oil fuels;
  • that derive at least 50% of their revenues from exploration, extraction, manufacturing or distribution of gaseous fuels; 
  • that derive at least 50% of their revenues from exploration, extraction, manufacturing or distribution from electricity generation with GHG intensity of more than 100g CO2 e/kWh; and
• Invest “meaningfully” in SFDR-aligned “sustainable investments”. 

So, it seemed that the for 8+ products a fund manager should invest “meaningful” in sustainable investments whereas before it required a 50% threshold. Did ESMA intend to aggravate or lighten this requirement? 

Final Report 

The final report published on May 14, 2024, includes changes to the proposed draft, but does not give further guidance on investing “meaningfully. However, ESMA is of the opinion that the system proposed is at the same time easy to understand and to apply. 

We beg to differ. From the final report you could derive 8 categories under which a fund name with ESG or sustainability related terms might fall. Also applying the list of explanations of key terms used might cause question marks. For instance, a fund name with the term “net-zero” equals the regime for transition related terms and not environmental. As well as the fact that an investor might not know what to expect from a meaningful number of sustainable investments. We would not be surprised that all in all it leaves investors somewhat puzzled behind.

Next steps

The guidelines apply three months after the date of its publication on ESMA’s website in all EU official languages. New funds launched after the date of application of the guidelines, should apply these guidelines immediately. Fund managers of existing funds should apply these guidelines for these funds after six months from the application date of the Guidelines. 

As the above shows it will not always be easy to determine which set of requirements applies, for example, if the fund uses words in different contexts or names that fall under more than one set of requirements. And maybe you as a fund manager are just as puzzled as we believe your investors might be. Either way, you are are advised to review your “green” funds (funds that use ESG/sustainability-related terms) to assess if they meet these criteria. 

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