ESMA finalises labelling rules for sustainable funds

Sustainable investment commentators criticise adjustments to thresholds

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Michael Nelson

The European Securities and Markets Authority (ESMA) has confirmed the final guidelines on when and how funds can label themselves sustainable, with some modifications from the original proposal.

For example, ESMA has decided to remove the 50% threshold for sustainable investments, a measure that had been criticised by stakeholders because the definition of a ‘sustainable investment’ under Article 2(17) of the Sustainable Finance Disclosure Regulation (SFDR) was considered too open to discretion by fund managers to function effectively as a specific threshold.

ESMA has instead introduced a commitment to invest meaningfully in sustainable investments for the use of any sustainability-related words in funds’ names.

The 80% threshold related to the investments used to meet environmental and/or social characteristics or sustainable investment objectives, however, has been retained and has been applied to all terms in the guidelines.

Elsewhere, ESMA has adjusted the minimum safeguards after consultation respondents criticised the “one size fits all” approach that required exclusions based on the Paris-aligned Benchmarks (PAB) for all ESG and sustainability-related terms in fund names. Respondents highlighted since PAB exclusions include certain revenue-based fossil fuel companies, some transition-focused strategies could not use appropriate terms in their names.

Recognising this, ESMA will now require the use of the Climate Transition Benchmark (CTB) exclusion criteria for terms that are “transition-, social- and governance-related”. CTB exclusions refer to companies involved in any activities related to controversial weapons, companies involved in the cultivation and production of tobacco and companies 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.

Funds using ‘impact’- or ‘transition’-related terms will also need to demonstrate a positive, measurable impact. According to ESMA, this would “help catch a wide set of terms that give the impression of a positive evolution towards the goals described in the objectives”.

In a statement announcing the rules, ESMA said that the objective of the guidelines “is to ensure investors are protected against unsubstantiated or exaggerated sustainability claims in fund names”, and to “provide asset managers with clear and measurable criteria to assess their ability to use ESG or sustainability-related terms in fund names”.

The final rules are subject to a transitional period of six months for existing funds, giving managers of existing funds a minimum of nine months in total to comply.


Niels Fibæk-Jensen, co-founder and CEO sustainability data and analytics solutions provider, Matter, added: “This move by ESMA is another in a recent line of actions geared towards increasing transparency for investors. To avoid unwittingly greenwashing, investors need to be able to interact directly with the data, to be able to screen for very specific things to be more accurate in their assessments of how an asset fits into a wider ESG investing strategy. This is why we are seeing a push from sophisticated investors towards a lot more granular data than traditional, broad rating and scoring solutions.”

However, for Seb Beloe, head of research at WHEB Asset Management, ESMA could have gone much further. 

“While a threshold mechanism is an important part of the naming criteria and ESMA has made some headway, in principle, reasonable fund buyers would expect every investment held in an investment fund to be aligned with the stated objectives of that investment fund,” argued Beloe.

“A threshold of 100% would be more appropriate. In practice, funds often hold a proportion of their assets in cash or in other instruments for liquidity purposes. These should be excluded from the calculation. It may be that there are other securities held for short periods that may also not align with the stated investment objectives of the fund. We would therefore propose that a threshold of 90%, not including cash and other instruments held for liquidity purposes, is appropriate. Furthermore, managers should be required to explain and justify any investments that do not align with the stated objectives of the investment fund.”

Bhavik Parekh, research associate at MainStreet Partners, agreed: “Requirements on aligning the fund to the necessary PAB or Climate Transition Benchmark CTB in terms of exclusionary criteria will likely have some positive effect, and clarification around the use of transition-related terms is helpful. However, where we have been disappointed is with the removal of the requirement to have a minimum of 50% in sustainable investments for a strategy with sustainability related terms in the name. While we can see the pros and cons of doing so, asking asset managers to instead ensure they ‘invest meaningfully’ is highly open to interpretation. 

“Too often have we seen funds classified as Article 8 under the SFDR with the term ‘Sustainable’ in the name commit to a minimum of only 10% or 20% in sustainable investments, a bar we consider to be far too low. The quantitative threshold of 80% for ‘E’ and/or ‘S’ characteristics or the sustainable investment objective is welcome and may help to solve some of the issues around poor commitment we see in the market currently.”

Additionally, while Beloe said there should be specific provisions for ‘impact’- and ‘transition’-related terms, all fund using impact-related words in their name should be required to provide a clear statement on how the assets of the fund will contribute to the change, and how the fund aims to contribute to that change via its investment activities.

“An impact fund needs to explain details about the intended changes that the fund will support and manage towards, and the mechanisms and instruments through which the fund will work with and support portfolio companies in creating real-world impact. Transparency of impact investing funds, including in their pre-contractual disclosures, about these elements and the reasoning behind them, would address questions related to intentionality and investor contribution. We would propose requiring a clear statement of investment objectives and disclosures of results.”

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