Plans to introduce formal guidance on ESG terms in fund names in the EU are still underway, with an amendment to an existing directive potentially presenting a new opportunity for the European Securities and Markets Authority (ESMA) to tackle the issue.
The regulator published draft proposals on ESG fund names in November 2022, suggesting that funds with ESG-related words would have to invest at least 80 percent of assets towards meeting environmental or social characteristics, or sustainability objectives defined in the strategy.
Those with sustainability-related terms should allocate at least half of their assets to sustainable investments as defined under the Sustainable Finance Disclosure Regulation (SFDR).
Major investors have criticised proposals on ESG fund names, claiming that the timing of the proposals is bad, that they are based on unclear definitions, and that they may not be needed.
While investors were broadly supportive of ESMA’s push to crack down on the risk of greenwashing, they delivered sharp criticisms of timing, proposed thresholds and minimum exclusion criteria.
It had been expected that ESMA would announce the next steps or a final proposal in or around the end of the third quarter of this year, but this has not happened.
Antonio Barattelli, ESMA’s head of unit, investment management, told Responsible Investor that the regulator is still determined to tackle the issue. “We believe this is crucial to provide investor protection in this area so that investors are not misled.
“There are fund names that excessively sell certain sustainability features, when the underlying portfolio doesn’t necessarily match this. That’s what prompted our action to make sure investor protection is preserved in this space.”
The timeline for ESMA’s next steps is being considered, Barattelli said, partly due to the large amount of feedback received, which the regulator is still reviewing.
ESMA is also waiting for clarity on the final agreement and adoption of revisions to the Alternative Investment Fund Managers Directive (AIFMD) and undertakings for collective investment in transferable securities (UCITS) directives, he added.
This is because the legal text, which was provisionally agreed earlier this year, could give ESMA the mandate to take steps to prevent misleading fund names.
This mandate would not just cover sustainability terms – however, as ESMA has already consulted on such terms in fund names, it could potentially issue ESG/sustainability guidelines fairly swiftly if given such a mandate.
Asked about the process since ESMA’s consultation launch, and the investor pushback, Patrik Karlsson, senior policy officer, investment management, said: “We certainly know that industry has had some critical comments about the proposals, but I would say that if the name is so important, then obviously we are looking at the right issues.
“If the name is used in a way to show the sustainability of a product, then we don’t think it’s excessive to require some substance behind that name, which is the driving principle of our work on this.”
Barattelli reiterated that one of the drivers to introduce guidelines around fund names is uncertainty in the market around the SFDR categories, “especially when it comes to Article 8 and the lack of precise criteria”.
The European Commission last month launched a review of the SFDR Level 1 legislation, partly to tackle the confusion around Article 8 and 9 and the use of the disclosure categories as de facto labels.
Barattelli said ESMA is “conscious” of the changes to SFDR that the commission is considering, but noted that any changes coming out of the Level 1 review would likely not be implemented for several years.
“In the meantime, there is this risk out there,” he said. “That’s why we started and that’s why we still believe it will be important to set out some principles. I always go back to a very basic principle: say what you do and do what you say.”
Several market observers told RI that the commission does not want ESMA to introduce ESG fund name rules, but would rather deal with the issue in SFDR.
Notably, in the Level 1 consultation, the commission asks whether respondents agree that SFDR is the “appropriate legal instrument to deal with the accuracy and fairness of marketing communications and the use of sustainability-related names for financial products”.
A spokesperson for the Commission said it believes that “not only funds, but all financial products” should have names that are “clear and not misleading”.
“We are committed to tackle greenwashing, and we appreciate that ESMA is keeping this important topic high on the agenda,” they said. “We do believe, however, that it would be best tackled in the context of a potential review of the SFDR.
“Indeed, questions on potential product labels and possible rules on funds’ names are an important part of the targeted consultation which is currently running. We could build on ESMA’s work on funds’ names when taking the analysis forward.”
ESMA would not be drawn on what the final guidelines could look like or any expected changes from the draft proposal.
Three market observers have told RI that the 50 percent threshold of assets defined as sustainable under SFDR for funds with sustainability-related terms in their name would likely be dropped in ESMA’s final proposal.
Meanwhile, ESMA published a study this month on “ESG names and claims in the industry”. It concluded that an increasing number of funds include ESG terms in their names and that broad ESG terms are more popular than more specific environmental or social ones.
In addition, since mid-2017, a number of investment funds have changed their name to add ESG words.
“Our findings support recent regulatory efforts – both in the EU and abroad – regarding disclosure requirements for investment funds,” the report said. “For example, the evolution of ESG language in fund names demonstrates the usefulness of ESMA’s recent public consultation on guidelines to ensure fund names accurately reflect their portfolio from an ESG perspective.”
The study met with scepticism from one market participant, who said it was “obvious” that there has been an increase in funds with ESG-related names in recent years, particularly given the regulatory push on sustainability disclosures.
“It’s clearly a very quick way to justify something that no one, including the commission, wants them to do,” they added.