ESG: ESMA Guidelines on fund names published

On 14 May 2024, ESMA published its Final Report, “Guidelines on funds’ names using ESG or sustainability-related terms”.

ESMA originally consulted on its proposals between November 2022 and February 2023 – at the time, it expected to publish final guidelines in Q2 or Q3 of 2023. Our summary of the Consultation Paper (CP) can be found here

In light of feedback received from 125 respondents, ESMA has made a number of changes to the guidelines on which it consulted - we look at some of these below.

Our client note, which looks at the key issues arising out of the Guidelines in more depth can be found here.

What’s the background to the Guidelines?

The Final Report notes that investor demand for investment funds that incorporate ESG factors has grown sharply recently and is expected to continue to do so. The resultant incentive for asset managers to include terminology in their funds’ names to attract investor assets has led to concerns in ESMA.

ESMA’s Supervisory Briefing on sustainability risks and disclosures in the area of investment management (May 2022) contained (among other things) principles-based guidance for funds’ names with ESG and sustainability-related terms. See our summary of the Supervisory Briefing here.)

In addition, the Amending Directive which brought in changes to the AIFMD and the UCITS Directive contained new mandates for ESMA to develop guidelines specifying the circumstances where the name of an AIF or UCITS is unclear, unfair, or misleading.

What happens next?

The Guidelines are now translated into the official languages of the EU before being formally published on ESMA’s website.

The date of publication is important as:

~ it triggers a two month period for the NCAs to tell ESMA whether or not they will comply with the Guidelines and

~ the Guidelines will apply three months after publication (although see below for transitional provisions for funds existing at the date of application).

ESMA’s mandates under AIFMD and the UCITS Directive, referred to above, relate to funds’ names in general, not only sustainability-related ones. The Final Report notes that will consider wider guidelines “in due course “, following a separate consultation.

ESMA also flags that it will review the guidelines, “in case of any update of the relevant legislation”.

Changes from proposed draft

ESMA received 125 responses to its CP and these have led to a number of changes being made to the provisions on which it consulted.

• Removal of the 50% threshold for sustainable investments

The CP proposed that, where a fund’s name contains the word “sustainable” (or any other term derived from it), within the 80% of investments to “meet the characteristics/objectives”, it should allocate “at least 50% of minimum proportion of sustainable investments” as defined by the SFDR.

The measure was criticised by respondents who felt that the definition in Article 2(17) of the SFDR is too open to discretion by fund managers for it to function effectively as a specific threshold (and the European Commission’s Q&As on the SFDR agreed that “the notion of sustainable investment can […] also be measured at the level of a company and not only at the level of a specific activity”.

As a result, ESMA has decided to remove the 50% threshold for sustainable investments and, instead, to introduce a commitment to invest meaningfully in sustainable investments for the use of any sustainability-related words in funds’ names.

Note, though that the 80% threshold proposed in ESMA’s CP (which was related to the investments used to meet environmental and/or social characteristics or sustainable investment objectives) has been retained.

• Minimum safeguards

The CP’s proposals to include exclusion criteria for Paris-aligned Benchmarks (PAB) for all investment funds using an ESG- or sustainability-related term in their name were criticised by respondents for being "one size fits all" - as PAB exclusions include certain revenue-based fossil fuel companies, it was pointed out that some transition focused strategies could not use appropriate terms in their names.

ESMA accepts that the fossil fuel exclusions in PAB could penalise some funds using terms in their name that are not environmental or that focus on transition strategies. As a result, the exclusion criteria of the Climate Transition Benchmark are instead provided for terms that are transition-, social- and governance-related.

• Category for transition-related terms

Taking feedback on transition terms into account, ESMA has introduced a new category for transition-related terms - the provisions require, in addition to the 80% threshold, the application of CTB exclusions only. This is designed not to penalise investment in companies which derive revenue from fossil fuels.

Transition-related terms include words such as “improving”, “progress/ion”, “evolution”, “transformation”, and any related words.

• Impact and transition terms: measurability

ESMA has also included a further provision for funds using impact- or transition-related terms in their names, in addition to meeting the 80% threshold and exclusion criteria.

~ Funds using impact-related terms (including the word “impact” itself or “impact investing”) in their name should ensure that their investments under the minimum proportions are made “with the intention to generate positive, measurable social or environmental impact” as well as a financial return.

~ Funds using a “transition”-related word in their name should demonstrate that the investments are on a clear and measurable path to social or environmental transition.

• Transitional period

The Final Report notes that “[a] slight majority” of the 125 respondents disagreed with ESMA’s proposal for a six month transitional period – 38 suggested it should be twelve months and a further twelve proposed a longer period. Even so, ESMA has decided to stick with what it refers to as its “very generous” provision.

As such:

~ The Guidelines start to apply three months after they are published in translation on the ESMA website.

~ Where a fund is set up after the Guidelines start to apply its manager is expected to apply the Guidelines immediately

~ Where a fund was already in existence before the Guidelines start to apply, its manager will have a period of 6 months after the date of application in which to comply. (This means that the manager will have at least nine months from the formal publication of the Guidelines.)