ESMA guidelines for naming ESG and sustainability-related funds

BACKGROUND

ESMA's guidelines on naming sustainable funds should be seen in the context of several initiatives that ESMA has undertaken to reduce and prevent so-called "greenwashing" (i.e., marketing products as more environmentally friendly and sustainable than they are). The guidelines aim to ensure that the names of funds reflect the investment objectives, policies, and strategies set out in their key documents, such as investor information documents. ESMA's guidelines on naming sustainable funds will apply to investment management companies, managers of alternative investment funds (FAIFs), managers of European venture capital funds (EuVECAs), European social entrepreneurship funds (EuSEFs), and European long-term investment funds (ELTIFs).

WHAT DOES THE DRAFT GUIDANCE CONTAIN?

In general, the consultation draft of ESMA's guidelines on naming sustainable funds ("ESMA Guidelines") proposes requirements that the names of funds, both constitutionally in their key documents and in marketing, must not be misleading. This means that funds can only use ESG and sustainability-related terms in their names when substantiated in a material way. In other words, it must be proven that the fund has specific sustainability-related characteristics or purposes.

The ESMA Guidelines propose addressing greenwashing in funds by introducing quantitative thresholds for when a fund may use ESG and sustainability-related terms in their names without it being considered misleading. In this update, we will focus on the two quantitative thresholds that are central points in the consultation draft of the ESMA Guidelines:

1. Use of ESG-related terms

Firstly, the ESMA Guidelines require that if a fund uses an ESG-related term in its name, at least 80% of the fund's investments must be used to achieve either the environmental or social characteristics or the sustainable investment objectives (collectively referred to as "ESG objectives") disclosed by the fund in its binding investment strategy, including the disclosure requirements the fund must comply with under Annex II and III of Regulation (EU) 2019/2088 on sustainability-related disclosures in the financial services sector (the "delegated SFDR regulation").

2.    Use of sustainability-related terms

Secondly, the ESMA Guidelines require that if a fund uses the word "sustainable" or any other word derived from the term "sustainable" in its name, within 80% of the fund's investments in the ESG objectives disclosed in its binding investment strategy, at least 50% of the investments must be allocated to "sustainable investments" as defined by the SFDR regulation

FINANS DANMARK'S RESPONSE TO THE CONSULTATION

On 21 February 2023, Finans Danmark published its response to ESMA's consultation. It states that Finans Danmark supports the intended changes and backs the harmonization of rules for naming sustainable funds at the EU level.

However, Finans Danmark highlights that certain legal uncertainties regarding the sustainability disclosure obligations imposed on funds under the SFDR regulation should be considered in the drafting of the guidelines, including the uncertainty surrounding the definition of "sustainable investments" therein.

Furthermore, Finans Danmark points out that the same rules for naming funds should apply as those applicable to other financial products covered by the SFDR regulation to ensure a level playing field for all financial products.

You can read Finans Danmark's full response to the consultation here.

WHAT'S NEXT?

The deadline for submitting responses to ESMA's consultation expired on 20 February 2023 and ESMA will now proceed to develop the final version of the ESMA Guidelines. In the context of the consultation process, the report produced by the Securities and Markets Stakeholder Group (SMSG) is particularly relevant. The report emphasizes that the naming of investment funds can significantly influence investors' perceptions and expectations of a fund, making it an important consideration for fund managers and regulatory authorities. SMSG recommends that ESMA should develop guidelines and principles for fund naming and enhance their supervision in this area.

The report also describes various naming practices used in the investment industry and identifies some challenges and risks associated with certain practices. SMSG calls for more transparency and standardization in the naming process for investment funds and suggests some principles that can help ensure clear and accurate naming of funds. The report also recommends that ESMA should collaborate with national supervisory authorities to promote consistency and coherence in fund naming across EU countries. Finally, the report encourages ongoing dialogue and feedback between investors, fund managers, and regulatory authorities regarding naming practices for investment funds.

LUND ELMER SANDAGER's comments

We expect that the guidelines will be ready for publication in Q2 or Q3 2023. The ESMA Guidelines will come into effect three months after their publication on ESMA's website. However, there will be a six-month transition period for funds that existed at the time of publication, allowing them to adjust to the new requirements outlined in the ESMA Guidelines.

If you have any questions regarding the guidelines and the new requirements, please contact partner Kim Høibye or attorney Jakub Zakrzewski from our Banking and Finance team.