Background
Investor demand for investment funds that incorporate environmental, social and governance (ESG) factors is growing sharply. This creates incentives for asset managers to include terminology in their funds’ names designed to attract investor assets, such as green or green or socially sustainable.
The use of such terminology has led to concerns within the European Securities and Markets Authority (ESMA), the EU’s financial markets regulator and supervisor, that misleading sustainability disclosures may give rise to risk of “greenwashing", when sufficient sustainability standards commensurate with that name have not satisfied.
Against this background, ESMA consulted in November 2022 on guidelines for investment funds using ESG or sustainability-related terms in their names and received significant input from stakeholders. ESMA has also monitored developments in the negotiations on the legislative review of the Alternative Investment Funds Directive (AIFMD) which has provided a direct legal mandate to ESMA to develop such guidelines.
Publication of Guidelines
On 14 May 2024, ESMA published a final report ("Final Report") containing Guidelines on funds’ names using ESG or sustainability-related terms. The Guidelines are set out in Annex IV of the Final Report.
The objective of the Guidelines is to protect investors against unsubstantiated or exaggerated sustainability claims in fund names, and provide asset managers with clear and measurable criteria to assess their ability to use ESG or sustainability-related terms in fund names.
The Guidelines establish that to be able to use these terms, a minimum threshold of 80% of investments should be used to meet environmental, social characteristics or sustainable investment objectives.
The Guidelines also apply exclusion criteria for different terms used in fund names:
- “Environmental,” “Impact” and “sustainability”-related terms: exclusions according to the rules applicable to Paris-aligned Benchmarks (PaB); and
- “Transition, “Social” and “Governance”-related terms: exclusions according to the rules applicable to Climate Transition Benchmarks (CTB).
In cases of a combination of terms, use of transition, sustainability- and impact-related terms, and for funds designating an index as a reference benchmark, further criteria are specified in the Guidelines.
The timeliness of the Guidelines is underscored by recent research by sustainability technology platform, Clarity AI. It suggests that nearly half of funds using environmental and impact terms may be invested in assets that breach the PaB exclusionary criteria, with the fossil fuels criteria as the most common problem area, including more than 1,000 funds invested in companies that breached the 10% revenue from oil rule. Additionally, nearly 500 were invested in companies involved in the production of controversial weapons, 60 in companies involved in tobacco production, and 67 in companies in companies with emissions-intensive electricity generation
Next Steps
The Guidelines in the report will be translated into the official EU languages and published on the ESMA website. The Guidelines will apply from three months after the publication of the translations, subject to a transitional period for funds existing before the application date, which will be six months after that date. Any new funds created after the application date should apply these Guidelines immediately in respect of those funds.
For more information, please contact John Gaffney, Daniel Cashman, or your usual contact in Beauchamps.