ESMA’s final guidelines on the use of ESG and sustainability related terms in fund names

On 14 May 2024, ESMA published final guidelines restricting the use of ESG and sustainability-related terms in the names of funds. The driver behind these guidelines is ESMA’s concern that the names of funds are a significant contributor towards investors’ expectations around the characteristics and objectives of the fund, and hence a potential source of greenwashing risk. ESMA wants to ensure that fund names are appropriately aligned with investment strategies so that greenwashing risk is minimized.

In terms of the population of funds that will be caught by these guidelines, ESMA has identified 6.490 funds with ESG-related terms in their names. These include 1,702 AIFs and 4,788 UCITS funds. Among the 4,788 UCITS funds are 287 Article 6 funds, 3,654 Article 8 funds and 847 Article 9 funds.

Greenwashing concerns around fund names is a key regulatory concern around the globe – both the FCA in the UK and SEC in the US have also published various rules restricting the use of ESG-related terms in fund names.

This note summarises ESMA’s new guidelines and gives our view on three key challenges for firms. The guidelines will be translated into the official EU languages and published on the ESMA website. They will apply from three months after publication, subject to some transitional provisions for managers of funds existing before the date of application.

Feel free to get in touch with us if you would like to discuss the new guidelines.
 

The 80% threshold

If a fund has any ESG-related terms in its name, or a term derived from the word “sustainable”, a minimum proportion of 80% of its assets should be used to meet the environmental or social characteristics, or sustainability investment objectives in accordance with the binding elements of the investment strategy, as disclosed in Annexes II and III of the SFDR. 

Terms derived from “sustainable”

The term “sustainable” or “sustainability” should be used only by (i) funds disclosing Article 9 SFDR; (ii) funds disclosing under Article 8 SFDR which in part invest in economic activities that contribute to environmental or social objectives; and (iii) funds disclosing under Article 5 of the Taxonomy Regulation. Other than the 80% threshold, these funds also need to apply the exclusions under the EU’s Paris Aligned Benchmark (see Annex below) and “commit to invest meaningfully in sustainability investments” (sustainability investments as defined in SFDR).
 

Within the umbrella of ESG-related terms, please note the following requirements for environment, impact, transitional, social and governance-related terms respectively.

Environment-related terms

Funds that use environment-related terms in their names should comply with the aforementioned 80% threshold and apply the exclusions under the EU’s Paris Aligned Benchmark. The commonly used “ESG” and “SRI” abbreviations are considered as environment-related terms.

Transition-, social-, and governance-related terms

Funds that have transition-, social- or governance-related terms in their names should comply with the aforementioned 80% threshold and also apply the exclusions under the EU’s Climate Transition Benchmark (see Annex below). When using transition-related terms, fund managers should demonstrate that the investments are on a clear and measurable path to social or environmental transition.

Impact-related terms

When using impact-related terms, fund managers should ensure that investments within the 80% threshold are made with the intention to generate positive measurable social or environmental impact alongside a financial return, and apply the exclusions under the EU’s Paris Aligned Benchmark.

Combination of environment- and impact-related terms

Where environmental terms are used in combination with transition-related terms, the exclusions under the EU’s Climate Transition Benchmark should be used (this does not apply to any terms derived from the word “sustainable”).

Key challenges for firms

• Firms operating globally will also be subject to new naming conventions issued by the SEC, FCA and other regulators such as MAS in Singapore. Firms will need to consider whether to stop operating in some jurisdictions or comply individually with multiple jurisdictions. Firms will also need to assess whether it is possible to name funds in a way that they are compliant with multiple jurisdictions.
• For funds with transition-related terms, firms will need to find the right KPIs to demonstrate a “clear and measurable path towards progress”, and consider whether they will have access to the KPIs long term to continue to demonstrate this.
• No exhaustive dictionary of terms has been provided – firms will need to be clear about which terms they consider to be environment-, transition-, or social/governance-related, and ensure a consistent understanding in-house.

Annex

• The exclusions in the Paris Aligned Benchmark are contained in Article 12(1)(a)-(g) of Commission Delegated Regulation (EU) 2020/1818) and include: 
  • Companies involved in any activities related to controversial weapons;o Companies involved in the cultivation and production of tobacco; 
  • Companies that benchmark administrators find in violation of the UNGC principles or the OECD Guidelines for Multinational Enterprises; 
  • Companies that derive 1% or more of their revenues from the exploration, mining, extraction, distribution or refining or hard coal and lignite; 
  • Companies that derive 10% or more of their revenues from the exploration, extraction, distribution or refining of oil fuels;o Companies that derive 50% or more of their revenues from the exploration, extraction, manufacturing, or distribution or gaseous fuels; and
  • Companies that derive 50% or more of their revenues from electricity generation with a GHG intensity of more than 100 g CO2 e/kWH.
• The exclusions in the Climate Transition Benchmark are the first three points in the above list i.e.:  
  • Companies involved in any activities related to controversial weapons;
  • Companies involved in the cultivation and production of tobacco; and 
  • Companies that benchmark administrators find in violation of the UNGC principles or the OECD Guidelines for Multinational Enterprises.