Final guidelines issued on funds using ESG or sustainability-related terms in names

The European Securities and Markets Authority (ESMA) recently published its final report on guidelines for investment funds using ESG (Environmental, Social, and Governance) or sustainability-related terms in their names.

Importance of the guidelines

In recent years, investor demand for funds incorporating ESG factors has surged, prompting funds to include such terminology in their names. As a fund’s name is often the first piece of information investors see, there’s a risk of misleading disclosures, potentially leading to greenwashing. These guidelines aim to enhance transparency, prevent greenwashing, and foster trust in sustainable investing.

Key terms

The guidelines identify several key terms relevant to funds’ names:

• Environmental, social, and governance terms that imply the promotion of ESG characteristics
• Sustainability-related terms
• Transition-related terms derived from words like “transition,” “improve,” “progress,” “evolution,” “transformation,” “net-zero,” etc
• Impact-related terms

Recommendations for fund managers

Threshold requirements: Funds using any of the above key terms must ensure that at least 80% of their investments are used to meet environmental and social characteristics or sustainable objectives, in line with the binding elements of the investment strategy.

Exclusion criteria: The guidelines introduce minimum safeguards, including exclusion criteria from Paris-aligned Benchmarks (PAB), as defined in the Benchmark Regulation Delegated Regulation (CDR (EU) 2020/1818). Funds using any of the defined key terms must exclude investments in companies:

• Involved in any activities related to controversial weapons
• Involved in the cultivation and production of tobacco, and
• That benchmark administrators find in violation of the United Nations Global Compact principles or the Organisation for Economic Cooperation and Development Guidelines for Multinational Enterprises

Additionally, funds using environmental, sustainable, or impact-related terms must exclude investments in companies that:

• Derive 1% or more of their revenues from exploration, mining, extraction, distribution or refining of hard coal and lignite
• Derive 10% or more of their revenues from the exploration, extraction, distribution or refining of oil fuels
• Derive 50% or more of their revenues from the exploration, extraction, manufacturing or distribution of gaseous fuels, and
• Derive 50% or more of their revenues from electricity generation with a greenhouse gas intensity above 100 g CO2 e/kWh

Specific types of funds

• Sustainability-related terms: Funds must commit to invest meaningfully in substantial investments as defined in Article 2(17) of the SFDR
• Transition or impact-related terms: Investments must be on a clear, measurable path to social or environmental transition or aim to generate a positive, measurable impact alongside financial returns

Implementation timeline

The guidelines come into force three months after publication and apply immediately to new funds. Existing funds have a transitional period of six months, providing fund managers a total of nine months to comply after the publication of translations.

Supervisory expectations

The Commission de Surveillance du Secteur Financier (CSSF) must consider these recommendations throughout the fund’s lifecycle. Temporary deviations from the thresholds and exclusions should be treated as passive breaches and corrected in the investors’ best interests, provided the deviations are not deliberate choices by the fund manager.

Conclusion

ESMA’s new guidelines mark a significant step towards greater transparency and accountability in the ESG investment space. By setting clear standards and requiring rigorous disclosure, these guidelines aim to protect investors and ensure that funds marketed as sustainable genuinely contribute to environmental and social goals.

For further details, you can access the full report on ESMA’s website here.

Talk to IQ-EQ

For fund promoters with Luxembourg-based vehicles, understanding these changes is crucial. If you need more detailed insights or assistance with compliance, feel free to contact us. Our expertise can help you navigate these regulatory updates effectively.