What's in a name? European guidelines for the use of ESG-related terms in fund names finalised

On 14 May 2024, ESMA published its final report on Guidelines on funds' names using ESG or sustainability-related terms (ESMA/34-472-440) (the "Guidelines"). This follows on from ESMA's original consultation (see our previous briefing here).

The objective of the Guidelines is to combat greenwashing and ensure that where the name of funds indicate an ESG objective or criteria, the portfolio and investment process reflects that profile. 

Where the Guidelines apply, either funds will need to ensure that their names do not trigger the requirements on investment criteria or, alternatively, that the investment objective or criteria of the fund complies with the Guidelines as a result of the name.  

In comparison to similar UK rules the EU guidelines apply only to the name of the fund, and not ESG-related terms in other legal or marketing documents.

Scope

The Guidelines apply to UCITS management companies (and self-managed UCITS), AIFMs (including internally managed AIFs), EuVECA, EuSEF and ELTIF as well as money-market funds – under the condition they use ESG or sustainability-related terms in their name.

These terms can be broadly grouped into:

• Transition terms: any terms derived from "transition", including "improve", "progress", "evolution", "transformation", "net-zero".
• Social terms: "Social"-related terms, e.g., "social" or "equality".
• Governance terms: "Governance"-related terms, e.g., "governance" or "controversies".
• Environmental terms: any "environmental"-related terms, such as "environmental", "green, "climate", "ESG" or "SRI".
• Impact terms: "Impact"-related terms.
• Sustainable terms: Any terms derived from "sustainable", including "sustainably" or "sustainability".

In its answer to the feedback received during the consultation, ESMA takes the view that the Guidelines also apply to closed-ended funds which are no longer open for investments. (This could be problematic because it may mean that changes could be needed for some funds that were deemed to be out of scope of the SFDR when it first entered into.) 

In respect of funds using an index as reference benchmark, ESMA clarifies that such funds should only use any of the foregoing terms in their name if they comply with the requirements set out in the Guidelines as well.

Requirements applicable to in-scope funds

• Funds using transition-, social- and governance-related terms

ESMA requires funds using such terms to

i. Invest at least 80% of their assets in investments used to meet the environmental and/or social characteristics promoted or the sustainable investment objectives; and

ii. Comply with the Climate Transition Benchmark exclusions under article 12 (1) lit. (a) to (c) of Commission Delegated Regulation (EU) 2020/1818.

Additional requirements apply to funds using transition-related terms: Their investments made to meet the 80% threshold must be "on a clear and measurable path to social or environmental transition."

• Funds using environmental- or impact-related terms

ESMA requires funds using such terms to

i. Invest at least 80% of its assets investments used to meet the environmental or social characteristics promoted or the sustainable investment objectives; and

ii. Comply with the Paris-aligned Benchmark exclusions under in article 12 (1) lit. (a) to (g) of Commission Delegated Regulation (EU) 2020/1818 (which are more restrictive than the Climate Transition Benchmark exclusions and comprise also fossil fuel related exclusions (coal and lignite, oil fuels, gaseous fuels and electricity generation with a high GHG intensity)).

Additional requirements for funds using impact-related terms: Investments made to meet the 80% threshold must be "made with the objective to generate a positive and measurable social or environmental impact in alongside a financial return."

• Funds using sustainability-related terms

ESMA requires funds using such terms to

• Invest at least 80% of their assets in investments used to meet the environmental and/or social characteristics promoted or the sustainable investment objectives;
• Comply with the Paris-aligned Benchmark exclusions under in article 12 (1) lit. (a) to (g) of Commission Delegated Regulation (EU) 2020/1818; and
• Commit to invest meaningfully in sustainable investments referred to in article 2 (17) SFDR.

ESMA has dropped the initial requirement to invest at least 50% in sustainable investments and replaced such threshold by "to invest meaningfully". It remains to be seen how national competent authorities construe such requirement – and whether they impose a majority investment in such sustainable investments.

• Funds using a combination of terms

ESMA considers that the requirements above apply on a cumulative basis - except when combined with any transition-related terms where only the requirements summarized in section II. 1) above will apply.

It should be noted that ESMA considers the abbreviations "ESG" and "SRI" as environmental terms.

Summary of requirements

Next steps

The Guidelines apply three months after the date of their publication on ESMA's website in all EU official languages. New funds are required to apply the Guidelines immediately, whereas existing funds benefit from an additional transition period of six months.

For the time being, the Guidelines are still being translated and have not yet been published.

In-scope firms should GAP analyse their existing fund restrictions and investment policies against the new requirements and where gaps are identified determine whether they will uplift their funds or change the fund name. 

Firms should also incorporate consideration of these new Guidelines into their fund launch process to ensure new products meet the requirements. We emphasise that the Guidelines apply independently of SFDR and that funds are not excluded from meeting the requirements set in the Guidelines simply by virtue of being an Article 8 or 9 fund under SFDR.

Authors: Lorraine Johnston, Partner; Detmar Loff, Partner; Hubert Blanc-Jouvan, Partner; Antonios Nezeritis, Partner; Arnaud Julien, Partner; Marc Hirtz, Counsel; Henry Glasford, Associate