ESMA Publishes Guidelines on Funds' Names Using ESG or Sustainability-Related Terms

On 14 May 2024 ESMA¹ published its final report² containing guidelines for investment funds using ESG or sustainability-related terms in their names (the Guidelines) – some eighteen months after publishing their consultation³ (the Consultation).

The purpose of the Guidelines is to ensure that 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.

Who do the Guidelines apply to?

These Guidelines apply to UCITS management companies, alternative investment fund managers (AIFMs) and competent authorities.⁴ “Fund” is defined in the Guidelines as a collective investment undertaking (as defined in Article 1(2)(a-b) of the UCITS Directive and Article 4(1)(a) of AIFMD).

The Guidelines

The Guidelines provide the following recommendations to fund managers on the use of terms in funds’ names:-

1. For funds using transition-, social- and governance-related terms:

A. a minimum of 80% of investments should be used to meet the environmental or social characteristics or sustainable investment objectives in accordance with the binding elements of the investment strategy, as disclosed in Annexes II and III of SFDR RTS.⁵

B. Investments should not be made in companies that are excluded from Climate Transition Benchmarks (CTB) (as set out in Article 12 “Exclusions for EU Paris-aligned Benchmarks” (1)(a) to (c) of Delegated Regulation (EU) 2020/1818⁶). CTB exclusions refer to companies:

a) involved in any activities related to controversial weapons

b) involved in the cultivation and production of tobacco; and

c) 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.

2. For funds using (i) environmental- or impact-related terms or (ii) sustainability-related terms:

A. a minimum 80% of investments should be used to meet the environmental or social characteristics or sustainable investment objectives in accordance with the binding elements of the investment strategy, as disclosed in Annexes II and III of SFDR RTS; and

B. investments should not be made in companies that are excluded from CTB (as set out in Article 12 “Exclusions for EU Paris-aligned Benchmarks” (1)(a) to (g) of Delegated Regulation (EU) 2020/1818). CTB exclusions include those listed at (a) to (c) in 1(B) above and in addition companies that derive:

a) 1% or more of their revenues from exploration, mining, extraction, distribution or refining of hard coal and lignite;

b) 10% or more of their revenues from the exploration, extraction, distribution or refining of oil fuels;

c) 50% or more of their revenues from the exploration, extraction, manufacturing or distribution of gaseous fuels; and

d) 50% or more of their revenues from electricity generation with a GHG intensity of more than 100 g CO2 e/kWh.

In addition, funds using sustainability-related terms should commit to invest meaningfully in “sustainable investments” as defined in Article 2(17) of SFDR.⁷

The Guidelines provide further recommendations for specific type of funds.

• Funds designating an index as a reference benchmark should only use transition-, social- and governance-related terms, environmental- or impact-related terms or sustainability-related term in their name if they fulfil the relevant requirements set out above.
• Funds using “transition-” or “impact”-related terms in their names should also ensure that investments used to meet the threshold are, as relevant, on a clear and measurable path to social or environmental transition or are made with the objective to generate a positive and measurable social or environmental impact alongside a financial return.

Explanations of key terms

The Guidelines also provide explanations of the key terms mentioned above.

• “Transition”-related terms encompass any terms derived from the base word “transition”. For example, “transitioning”, “transitional” etc. and those terms deriving from “improve”, “progress”, “evolution”, “transformation”, “net-zero”, etc. 
• “Environmental”-related terms mean any words giving the investor any impression of the promotion of environmental characteristics. For example, “green”, “environmental”, “climate” etc. These terms may also include “ESG” and “SRI” abbreviations. 
• “Social”-related terms mean any words giving the investor any impression of the promotion of social characteristics. For example, “social”, “equality”, etc. 
• “Governance”-related terms mean any words giving the investor any impression of a focus on governance. For example, “governance”, “controversies”, etc. 
• “Impact”-related terms mean any terms derived from the base word “impact”. For example, “impacting”, “impactful”, etc. 
• “Sustainability”-related terms mean any terms only derived from the base word “sustainable”. For example, “sustainably”, “sustainability”, etc.

When do the Guidelines apply?

• The Guidelines apply three months after the date of their publication on ESMA’s website in all EU official languages.
• Managers of any new funds created after the date of application of the Guidelines, should apply these guidelines immediately in respect of those funds.
• Managers of funds existing before the date of application of the Guidelines should apply these guidelines in respect of those funds after six months from the application date of the Guidelines.  Considering that the Guidelines will start applying three months after the publication of the translations, this will give managers of existing funds a minimum of nine months’ time in total to comply following the forthcoming publication of the translations.
• National competent authorities to which the Guidelines apply (NCAs) - and financial market participants - must make every effort to comply with the Guidelines. NCAs should incorporate the Guidelines into their national legal and/or supervisory frameworks as appropriate. The publication of the translations of the Guidelines on ESMA’s website in all EU official languages will trigger a two-month period during which NCAs must notify ESMA whether they (i) comply, (ii) do not comply, but intend to comply, or (iii) do not comply and do not intend to comply with the Guidelines. Given the focus on greenwashing concerns in the EU, it would be surprising if any NCA in a key jurisdiction for funds chose not to comply with the Guidelines.

Changes from the Consultation

ESMA received significant input from stakeholders to the Consultation and, in light of the feedback received, ESMA adjusted the guidelines in several areas. Most notably, the Consultation proposed that if a fund had the word “sustainable” or any other term derived from the word “sustainable” in its name, it should allocate, within the 80% of investments to “meet the characteristics/objectives”, at least 50% of minimum proportion of sustainable investments as defined by Article 2(17) SFDR) and as disclosed in Annexes II and III of SFDR RTS. However, ESMA decided to remove the 50% threshold for sustainable investments, and this threshold is not included in the Guidelines.

One other important change is that ESMA introduced a new category for transition-related terms, to further reflect the feedback related to transition terms.

In the Guidelines, unlike the Consultation, ESMA has separated the terms related to social (S) and governance (G) from environmental (E) terms. The social and governance terms are included in the same group as the transition terms, allowing funds with those terms in their name to apply the CTB exclusions only.

AIFMD 2.0

AIFMD 2.0 (Directive (EU) 2024/927), published in the Official Journal of the EU on 26 March 2024 ⁸ and which entered into force on 15 April 2024, mandates ESMA to develop guidelines specifying the circumstances where the name of an AIF or UCITS is unclear, unfair, or misleading. ESMA is to develop these guidelines by 16 April 2026. In a nod to potential future developments in EU legislation, the AIFMD 2.0 mandates note that new sectoral rules setting standards for fund names or marketing of funds will take precedence over any guidelines.

Conclusion

Fund managers, who have been waiting for the publication of the Guidelines for some time, will need to ensure they are familiar with the provisions of the Guidelines and the limitations on when they can use certain terms in their funds’ names, ensuring that future funds meet the requirements and bringing existing funds into compliance over approximately the next nine-month period. The Guidelines are principally directed at EU managers and do not, on their face, appear to apply to non-EU funds being marketed into the EU by non-EU managers, although EU Member States could include the Guidelines as part of their national private placement regime under AIFMD, particularly when AIFMD 2.0 applies.