The European Securities and Markets Authority (ESMA) has introduced new guidelines for investment funds using ESG or sustainability-related terms in their names. The aim of these guidelines, which came into effect on November 21, 2024, is to protect investors from greenwashing and ensure that fund names accurately reflect their investment strategies and sustainability commitments - feeling concerned or confused about the new changes? Keep reading to learn more.
Key Features of the Guidelines
80% Investment Threshold
The cornerstone of ESMA's new guidelines is the requirement that funds using ESG or sustainability-related terms in their names must invest at least 80% of their assets in investments that meet environmental or social characteristics or sustainable investment objectives. This threshold applies to all funds using such terms, regardless of the specific category they fall under.
Categorisation of Terms
The ESMA has categorised ESG and sustainability-related terms into six distinct groups, which are:
Transition-related: Includes words like "transition," "transitioning," "transitional," "improve," "progress," "transformation," and "net-zero".
Environmental-related: Includes words like "green," "environmental," "climate," and abbreviations such as "ESG" and "SRI".
Social-related: Includes words like "social" and "equality".
Governance-related: Includes words like "governance" and "controversies".
Impact-related: Includes terms derived from "impact," such as "impacting" and "impactful".
Sustainability-related: Includes terms derived from "sustainable," such as "sustainably" and "sustainability".
Each category has specific recommendations for fund managers to ensure compliance.
Example Requirements for Specific Terms
Impact-Related Terms: Funds using terms like "impact" or "impact investing" must demonstrate that their investments are intended to generate positive, measurable social or environmental impacts alongside financial returns.
Transition-Related Terms: Funds using terms such as "transition," "progress," "evolution," or "net-zero" must show that their investments are on a clear and measurable path to social or environmental transition.
Exclusion Criteria
The guidelines also introduce minimum safeguards, including exclusion criteria based on the Paris-Aligned Benchmarks (PAB) as defined in the Benchmark Regulation Delegated Regulation. These criteria aim to ensure that funds using ESG or sustainability-related terms avoid investments in controversial sectors or practices. For example, funds using broad sustainability, environmental, or impact-related terms in their names must exclude companies that are involved in any activities related to controversial weapons, are involved in the cultivation and production of tobacco, or derive 1% or more of their revenues from exploration, mining, extraction, distribution, or refining of hard coal and lignite. You can find a full list of the exclusions detailed in the PAB here.
Implementation Timeline
The guidelines are planned to follow a phased implementation approach:
For new funds, the guidelines apply immediately after the three-month translation period following their publication.
A six-month transitional period is provided for funds that existed before the application date, giving them until May 21, 2025, to comply.
Implications for the Industry
These new guidelines represent a significant shift in the regulatory landscape for ESG and sustainability-focused funds in the EU. They are expected to have several impacts:
Increased Transparency: The guidelines aim to provide investors with clearer information about the sustainability credentials of funds, potentially reducing confusion and misinformation in the market.
Operational Challenges: Fund managers may need to reassess and potentially restructure their portfolios to meet the 80% threshold and comply with the exclusion criteria.
Naming Conventions: Some funds may need to change their names if they cannot meet the new criteria, potentially affecting their marketing strategies.
Harmonisation Efforts: The guidelines contribute to the broader effort to standardise ESG investing practices across the EU, although some differences remain compared to other jurisdictions like the UK.
ESMA has recognised the need for further clarification on certain aspects of the guidelines, and on December 13, 2024, published Q&As to address issues such as the treatment of green bonds and the definition of controversial weapons.
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