The European Securities and Markets Authority’s (ESMA) new Fund Naming Guidelines create inconsistencies with other sustainable finance regulations, like the EU Green Bond Standard, which could hamper the growth of the corporate green bond sector, according to the European Fund and Asset Management Association (EFAMA).
Despite the EU being at the forefront of green bond issuances, regulatory inconsistency is a pressing concern. EFAMA explained current interpretations and clarifications in sustainable finance regulation dealing with use of proceeds instruments focus on the project being financed, not the broader activities of the issuing company. For instance, the EU Green Bond Standard (EU GBS) doesn’t restrict the eligibility of issuers and in particular does not exclude companies based on standards for Paris-aligned benchmarks (PAB).
However, the new fund naming rules do exclude companies on this basis, regardless of the project they are financing with the bond. This means a bond fund investing in green bonds might have to change names if it does not restrict the eligibility of bond issuers. Alternatively, the said fund could keep its name and divest from all bonds by issuers who generate parts of their revenues from PAB-excluded activities.
According to EFAMA, this restriction could limit the investable universe for green bond funds, particularly investments in corporate green bonds. Non-financial corporate issuers have accounted for between 26% and 34% of annual issuances in the green bond market over the past five years.
It could also undermine the future success of the recently created EU Green Bond Standard if major investors, like funds, were disincentivised from investing in certain EU GBS-compliant bonds.
Meanwhile, the largest corporate issuers are utility companies, which play a vital role in developing the infrastructure needed for a sustainable future. Excluding them from funds using sustainable or environmental terms in their names could raise their cost of capital, hinder key projects and slow down the energy transition.
Anyve Arakelijan, regulatory policy advisor at EFAMA, commented: “In sustainable finance regulation, the general interpretation has been that the project being financed should be the focus, not the wider activities of the issuing company. This is particularly relevant when it comes to funding the energy transition. To ensure consistency across regulations, this principle should also be applied within the fund naming guidelines. Our hope is that ESMA will see the logic of this when it comes to green bonds. If Europe wants to remain a world leader in sustainable finance, consistent understanding and application of key concepts will be crucial.”
EQ Investors’ head of sustainability, Louisiana Salge, agreed: “We support this interpretation that the level of exclusions should be applied to the economic activities level rather than issuers level. Economic activities financed by green bonds have already been deemed as sustainable if they follow green bond best practices – like proceed reporting, impact reporting and ring-fencing – because they finance environmental projects and therefore meet the requirement.
“I think some fund managers or index methodologies will also choose to apply a level of screening at the issuer level to assess strategy alignment, but I don’t think this needs to be mandated given that green bonds are one way to finance the brown-to-green transition, which should be encouraged.”
A spokesperson for ESMA addressed the criticism: “ESMA is considering certain specific issues related to the practical application of the guidelines on funds’ names using ESG- or sustainability-related terms, including whether there is a need to provide further guidance.”
