ESMA floats 40% SFDR requirement for funds with ‘sustainable’ in title

Morningstar says just 18% of current Article 8 funds would meet criteria proposed by EU financial markets regulator.

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Funds with “sustainable” in their name would be required to invest at least 40 percent of their assets in sustainable investments under proposed guidelines put out by the European Securities and Markets Authority (ESMA).

On Friday, the EU’s financial markets watchdog called for input from the market on new minimum “quantitative thresholds” for investment funds that use ESG- or sustainability-related terms in their title.

The draft guidelines, which will be out for consultation until 20 February 2023, seek to better align names of funds with their investments in a bid to combat potential greenwashing.

“The objective is to ensure that investors are protected against unsubstantiated or exaggerated sustainability claims while providing both NCAs [National Competent Authorities] and asset managers with clear and measurable criteria to assess names of funds including ESG or sustainability-related terms,” said Verena Ross, ESMA’s chair. 

ESMA’s proposal would mean that a fund with ESG-related words in its name would be required to invest at least 80 percent of its assets towards meeting the “environmental or social characteristics or sustainable investment objectives” defined in the strategy.  

Furthermore, funds that also have the word “sustainable” or any other term derived from it in their name should, within that 80 percent, allocate more than 50 percent to sustainable investments as defined by the Sustainable Finance Disclosure Regulation (SFDR), the EU’s anti-greenwashing regulation. 

The regulator described the 50 percent threshold, which would equate to 40 percent of the fund’s total assets, as an “appropriate proxy”. Funds disclosing under Article 8 SFDR that meet the minimum proportion of 80 percent would thus be “ensuring the consistency of their investments with the use of the word ‘sustainable’ or any other sustainability-related terms in their name”. 

Article 8 funds under SFDR are those that promote environmental or social characteristics.   

“ESMA is of the opinion that the proposed figure of 50 percent, in conjunction with the 80 percent 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,” the guidance added.  

Preliminary analysis by US data giant Morningstar posted on LinkedIn suggests that only 18 percent of existing Article 8 funds using the word “sustainable” in their name would meet ESMA’s criteria.

ESG fund names are also currently being scrutinised in the US by the Securities and Exchange Commission (SEC). The powerful financial regulator has proposed amendments to its “names rule”, expanding its scope to apply to funds suggesting ESG or sustainability factors are incorporated into investment decisions.

Similarly, in the UK, the Financial Conduct Authority (FCA) is proposing to introduce restrictions on how certain sustainability-related terms – such as “ESG”, “green” or “sustainable” – can be used in product names and marketing for products which do not qualify for sustainable investment labels.

ESMA’s guidance on Friday capped a busy week for Europe’s financial regulators. On Tuesday, the European Supervisory Authorities (ESAs) – which includes ESMA – put out a call to the market for examples of greenwashing.   

Then on Thursday they published a Q&A document which clarified that Article 9 funds – often referred to as “dark green” or impact funds – cannot rely on “broad market” indices as their reference benchmarks.