Following in the footsteps of similar initiatives by regulators in other jurisdictions, including the SEC’s recent tightening of investment company name requirements and the FCA’s rules around names and the marketing of investment products introduced as part of its Sustainability Disclosure Requirements and investment labelling regime, the European Securities and Markets Authority (“ESMA”) published its final Guidelines on funds’ names using ESG or sustainability-related terms (the “Guidelines”) on 14 May 2024.
The Guidelines reflect ESMA’s view, and the European legislative and supervisory authorities’ view more generally, that the name of a fund is a key element in communicating information about that fund to prospective investors and an important marketing tool for the fund.
With this in mind, the stated objective 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.
The Guidelines apply to managers of UCITS and AIFMs (including internally managed AIFs, EuVECA, EuSEF and ELTIF managers), as well as to competent authorities. Depending on the manner in which the Guidelines are interpreted by individual regulators and/or applied in national legal frameworks, they may extend to funds managed by non-EU managers which are notified for marketing in the European Economic Area.
‘Recommendations’ on Fund Names
The Guidelines include recommendations to fund managers on the use of the following categories of terms in funds’ names.
i) Transition, social and governance-related terms
“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.
“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.
A fund using such a term in its name should:
- ensure that 80% of its investments comply with the binding environmental and/or social characteristics (in the case of ‘Article 8’ funds) or the sustainable investment objectives (in the case of ‘Article 9’ funds), disclosed in each case in its SFDR pre-contractual disclosure annexes; and
- exclude investments in companies identified in Article 12(a)-(c) of Commission Delegated Regulation (EU) 2020/1818 of 17 July 2020 as regards minimum standards for EU Climate Transition Benchmarks and EU Paris-aligned Benchmarks (the “Minimum Standards Delegated Regulation”).
In response to feedback received during the consultation, ESMA has introduced a new category of ‘Transition-related terms.’ Whilst this is arguably the broadest and least defined set of terms subject to the Guidelines, the requirements applicable to these terms (in particular Limb (B), which only excludes a subset of the excluded investments in respect of ‘Environmental or impact-related terms’ and ‘Sustainability-related terms’) are designed so as not to penalise investment in companies deriving part of their revenues from fossil fuels, thus promoting strategies aimed to foster a path to transition towards a greener economy.
ii) Environmental or impact-related terms
“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.
“Impact”-related terms mean any terms derived from the base word “impact.” For example, “impacting,” “impactful,” etc.
A fund using such a term in its name should:
- ensure that 80% of its investments comply with the binding environmental and/or social characteristics (as applicable to ‘Article 8’ funds) or sustainable investment objectives (as applicable to ‘Article 9’ funds) disclosed in its SFDR pre-contractual disclosure annexes; and
- exclude investments in companies identified in Article 12(a)-(g) of the Minimum Standards Delegated Regulation.
iii) Sustainability-related terms
“Sustainability”-related terms mean any terms only derived from the base word “sustainable.” For example, “sustainably,” “sustainability,” etc.
A fund using such a term in its name should:
- ensure that 80% of its investments comply with the binding environmental and/or social characteristics (as applicable to ‘Article 8’ funds) or sustainable investment objectives (as applicable to ‘Article 9’ funds) disclosed in its SFDR pre-contractual disclosure annexes;
- exclude investments in companies identified in Article 12(a)-(g) of the Minimum Standards Delegated Regulation; and
- commit to invest meaningfully in sustainable investments as construed under the SFDR.
Limb (C) above was initially drafted so as to require a minimum proportion (50%) of a fund’s investments to constitute sustainable investments but, in a small nod to the market’s vigorous lobbying during the consultation period, ESMA has afforded managers greater flexibility by replacing this objective standard with a requirement that a fund do so meaningfully.
Points to Note
Whilst the Guidelines describe the three sets of in-scope terms in a relatively targeted manner, note that these descriptions (as reproduced above) are not expressed to be definitive or exhaustive. As such, managers should ensure that they are reading the Guidelines from a narrowly purposive approach.
The increasingly prescriptive requirements applicable to the use of the three sets of specified terms reflect ESMA’s view that these sets of terms give investors the impression of the application of differing levels of sustainability standards, and are therefore increasingly ‘powerful’ in their impact. Where terms are combined, the provisions must be applied cumulatively.
Note that the Guidelines are stated to apply in respect of all funds, irrespective of whether they constitute ‘Article 6,’ ‘Article 8’ or ‘Article 9’ funds for the purposes of the SFDR, and it remains to be seen whether Limb (A) in each case above will be construed to prohibit ‘Article 6’ funds (which do not prepare SFDR pre-contractual disclosure annexes) from using such terms altogether. In addition, ‘Sustainability-related terms’ would only be available to so-called ‘Article 8+’ funds (i.e. ‘Article 8’ funds which commit to investing in sustainable investments).
It is a pity that ESMA did not recognise that requiring 80% of a fund’s investments to comply with its binding environmental and/or social characteristics (as applicable to ‘Article 8’ funds) or sustainable investment objectives (as applicable to ‘Article 9’ funds), irrespective of the form and terms of the fund, may pose challenges for certain types of funds, including open-ended funds, which often maintain a sizeable portfolio of liquidity investments. The size of an open-ended fund’s liquid portfolio will vary depending on the fund’s specific features, and may be driven by regulatory requirements, but a 20% liquid portfolio is not uncommon within certain segments of the market. Hypothetically, to the extent that such liquid investments did not meet the fund’s binding environmental and/or social characteristics or sustainable investment objectives (as applicable), this would mean that the pool of illiquid investments would need to achieve 100% compliance, which may be difficult to achieve in practice.
The Guidelines follow hot on the heels of the finalisation updates to the Alternative Investment Fund Managers Directive (“AIFMD II”), which mandated ESMA to develop guidelines specifying the circumstances where the name of an AIF is unclear, unfair, or misleading and is the legal basis for the Guidelines. However, AIFMD II clarifies that sector-specific legislation will prevail over guidelines developed by ESMA under this mandate.
Next Steps
The Guidelines are due to be translated into the official languages of the EU and published on the ESMA website. The Guidelines will apply three months from the date of publication of the translations, subject to the transitional periods afforded to existing funds described below.
Note that the Guidelines are not in themselves technically binding on managers and other financial market participants. However, the regulators of individual Member States and financial markets participants must make every effort to comply with the Guidelines.
Individual regulators will have two months from the date of the publication of the translations to notify ESMA as to whether they comply, intend to comply or do not intend to comply with the Guidelines, including by incorporating the Guidelines into their relevant national legal frameworks and/or applying the Guidelines in their supervision of financial market participants.
Application to Existing Funds
During the consultation process, one of the market’s main concerns was the lack of an appropriate grandfathering provision for funds which are no longer open to subscription as at the time of the Guidelines coming into force. This area of focus was based on ESMA’s own view of a fund’s name as an important marketing tool, pursuant to which the market asked that closed-ended funds which are no longer being marketed be excluded from the impact of these rules.
However, ESMA was not forthcoming in this regard and, in the report which accompanied the Guidelines, stated its belief that the existing proposal was sufficiently generous and that there was value in ensuring the that names of even closed funds accord with the investments they hold.
As such, the Guidelines do not draw a distinction between funds which are open-ended and those which are closed-ended, nor between funds which remain open for subscription and those which are closed.
Instead, funds which are in existence at the date on which the Guidelines come into force are afforded an extra six months (i.e. a total of nine months from the date of publication of the translations) to comply with the Guidelines when compared to new funds.
Endnotes
1Companies identified in these provisions are those (1) involved in any activities related to controversial weapons; (2) involved in the cultivation and production of tobacco and (3) companies in violation of the United Nations Global Compact (UNGC) principles or the Organisation for Economic Cooperation and Development (OECD) Guidelines for Multinational Enterprises.(go back)
2Companies identified in these provisions are those (1) involved in any activities related to controversial weapons; (2) involved in the cultivation and production of tobacco; (3) in violation of the United Nations Global Compact (UNGC) principles or the Organisation for Economic Cooperation and Development (OECD) Guidelines for Multinational Enterprises; (4) which derive 1% or more of their revenues from exploration, mining, extraction, distribution or refining of hard coal and lignite; (5) that derive 10% or more of their revenues from the exploration, extraction, distribution or refining of oil fuels; (6) that derive 50% or more of their revenues from the exploration, extraction, manufacturing or distribution of gaseous fuels; and (7) that derive 50% or more of their revenues from electricity generation with a GHG intensity of more than 100 g CO2 e/kWh.(go back)
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