ESG Fund Names: What ESMA’s New Guidelines Mean For Issuers

With the ever-increasing interest in ESG investing comes concerns that financial products and funds that claim to be sustainable might be overselling their credentials in order to attract investors. 

All areas of business are becoming vigilant for so-called ‘greenwashing’, with the European Commission’s Green Claims Directive dealing with the way companies promote products to customers. Now, the European Securities and Markets Authority (ESMA) has set out new guidelines specifically for the financial markets, issuing requirements for asset managers who use terminology relating to environmental, social and governance matters in the names of their funds. 

Following a consultation, ESMA acted on feedback that the definition of ‘sustainable investment’ in Article 2(17) of the Sustainable Finance Disclosure Regulation (SFDR) was too open to discretion by fund managers and needed refining. 

One of the key pillars of SFDR was to provide transparency over which products can be classed as sustainable and, in the knowledge that revising the regulation might take years, ESMA decided to produce its guidelines on fund names using ESG or sustainability-related terms. 

This article explains the new rules regarding fund names, what they mean for those funds and how the guidelines might affect issuers. 

What are the new requirements for ESG fund names? 

ESMA issued its final guidelines on 14 May 2024 and put in place two main considerations for marketing funds with terms related to ESG or sustainability in the name:

1. Funds must meet a minimum threshold of 80% of investments that help the fund meet its environmental, social or sustainability objectives 
2. Funds must apply exclusions based on either Paris-aligned benchmarks (PAB) or climate-transition benchmarks (CTB) on products within funds, depending on the terms used in the fund’s name. 

Any product that fails to meet the appropriate benchmark cannot be counted towards the 80% of sustainable investments within the fund. 

In order to provide clear guidance to asset managers over how they name their funds, ESMA has created six categories related to terms they might use and the minimum requirements for each. They are:

*A sustainable investment, according to SFDR, is an economic activity “that contributes to an environmental objective, as measured, for example, by key resource efficiency indicators on the use of energy, renewable energy, raw materials, water and land, on the production of waste, and greenhouse gas emissions, or on its impact on biodiversity and the circular economy, or an investment in an economic activity that contributes to a social objective, in particular an investment that contributes to tackling inequality or that fosters social cohesion, social integration and labour relations, or an investment in human capital or economically or socially disadvantaged communities, provided that such investments do not significantly harm any of those objectives and that the investee companies follow good governance practices, in particular with respect to sound management structures, employee relations, remuneration of staff and tax compliance.”

Exclusions

The exclusions placed on the different types of funds derive from Article 12 of the Commission Delegated Regulation (EU) 2020/1818 of 17 July 2020 supplementing Regulation (EU) 2016/1011 of the European Parliament and of the Council as regards minimum standards for EU climate transition benchmarks and EU Paris-aligned benchmarks. 

This explains the criteria:

Who do the guidelines apply to?

The ESMA guidelines apply to management companies of Undertakings for Collective Investment in Transferable Securities (UCITS) and fund managers of Alternative Investment Funds (AIF) who use fund names that include terminology relevant to sustainability, ESG, impact and transition investing in the European Union. They apply to all documentation relating to the fund and to marketing materials aimed at investors and potential investors. 

National Competent Authorities (NCA) in member states are expected to incorporate the requirements into their local legal framework, with the ability to increase the minimum thresholds in their own country if they feel it to be necessary. 

When do they apply?

ESMA’s guidelines were published in English on 14 May 2024 and the authority began the process of translating them into the other languages of the EU. Once this is complete and all translated versions appear on the ESMA website, they will apply to new funds three months from that date and to existing funds six months from publication. 

Enforcement

NCAs should monitor the composition of in-scope funds throughout their lifecycle, requesting periodic disclosures from fund managers. If a fund deviates from the thresholds or exclusions temporarily, and as long as it was not a deliberate choice, it will be classed as a ‘passive breach’, allowing the fund manager to rectify it accordingly. 

Where there are non-passive breaches and where it is deemed that investors are receiving unfair or unclear information regarding the true sustainability or ESG performance of the fund, NCAs should investigate and enter a “supervisory dialogue” with the asset manager.  

Impact on funds

Investor group Morningstar identified 2,500 EU funds that it believes will be in-scope of the new guidelines and which provide stock holding data. Of those funds, it claims that 1,600 contain at least one stock that could be in breach of the exclusion rules for PAB or CTB. 

In these circumstances, Morningstar believes they will have to either rebrand their fund names to remove references to sustainability or ESG, or they will have to divest in non-compliant stocks. It also calculates that, if all 1,600 were to keep their ESG branding, they would have to divest in US$40 billion (€37.3 billion) of stock. 

Impact on issuers

Issuers whose financial products exceed the minimum standards for compliance with either the CTB or PAB will be concerned that funds will divest in those products in order to meet the requirements of ESMA’s new guidelines. 

For those that remain below the benchmarks, there could be new investment opportunities for issuers that can show evidence of strong ESG performance, with funds looking for more sustainable investments. 

Other issuers may worry that their products do not qualify as suitably sustainable due to poor ESG performance. To show the company’s commitment to the environment, social responsibility, good corporate governance and sustainability in general, it is important that issuers develop a coherent and impactful ESG strategy. 

Improving ESG performance – next steps

Issuers can achieve better ESG performance by creating a strategy using these steps:

• Ensuring commitment at all levels towards developing an ESG vision that can unite the company.
• Assessing the current policies and procedures in place to reach that ESG vision. 
• Setting sustainability goals that will help you improve those areas in which your performance requires improvement.
• Choosing an ESG framework that allows you to benchmark your performance and compare it with your peers
• Setting KPIs for ESG initiatives and monitoring and reporting on your progress towards them. 

For those companies in-scope of the Corporate Sustainability Reporting Directive (CSRD), your double materiality assessment against the European Sustainability Reporting Standards will help guide you towards the areas in which the business must improve to show a true commitment to sustainability.