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A regular briefing for the alternative asset management industry.
Today is a significant landmark in the UK's fight against greenwashing: the new "anti-greenwashing rule" – the first part of a package of reforms that many see as Britain's answer to the EU's SFDR – is effective from 31 May. As we have written previously, all UK-regulated firms will need to ensure that relevant communications comply with the FCA's detailed guidance, and many alternative asset managers have put in place sign off processes to catch any reference to sustainability in a wide range of marketing materials.
But the EU is also continuing to take aim at greenwashing, and recently published rules may cause more headaches. Although framed as "guidelines", they could force some firms to re-name certain financial products, including a number of private funds that are either already closed or currently in the market.
Guidelines on the use of ESG-related terms in the names of funds marketed by EU-regulated firms have been on the stocks for some time. The pan-EU supervisor, ESMA, first consulted on fund name guidelines in November 2022, but many respondents argued that ESMA lacked power to make fund naming rules without authority in primary legislation. Recent changes to the AIFMD (and the UCITS Directive) explicitly gave ESMA such power, and the final guidelines – which include several important modifications from the originally proposed draft – were published on 14 May 2024. (Our detailed note on the guidelines is here.)
ESMA's power to make these rules was certainly not the only objection to the 2022 proposals. Unfortunately, several legitimate questions and comments raised in the consultation responses were not addressed in the final guidelines, leaving some firms wondering how they can comply.
In short, sponsors with funds that include one or more specified words in their name will have to ensure that their portfolios align with a new quantitative threshold, and must exclude certain types of investment from their portfolio. Specified words include, for example, "sustainability", "green", "climate", "environmental", "impact" and "transition", but the rules also cover fund names that include terms (or common abbreviations) with similar implications, even if not specifically mentioned in the list. (Unlike > similar UK rules – which come into effect on 2 December – the EU guidelines apply only to the name of the fund, and not to use of ESG-related terms in other marketing communications.)
The rules vary according to the term used, with the most stringent requirements applying to funds with any term derived from the word "sustainable" in their name. These funds are required to have at least 80% of their portfolio in investments that match the sustainability characteristics promoted by the fund, to exclude investments that are prohibited by the > Benchmark Regulation, and to "invest meaningfully" (no minimum threshold is specified) in "sustainable investments" as defined by the SFDR.
Funds with names falling into other categories will have to comply with slightly different requirements, although all will need to ensure that 80% of investments are consistent with the ESG characteristics of the product.
ESMA's guidelines are not automatically binding. They are in the form of recommendations to EU national regulators – including, for example, the CSSF in Luxembourg and the CBI in Ireland – who can decide whether to apply them to the fund managers they regulate. National authorities have two months (from publication of the guidelines in all EU languages) to say whether they will apply the rules. There remains hope that, at least in some EU member states, the more difficult aspects of the rules will not be applied, and some industry associations may press for non- (or partial) adoption.
Among the objections to the guidelines are that fully closed, closed ended funds are not scoped out, even though the investors have already made a commitment to the fund that they cannot now rescind. Funds with only institutional investors are in scope, even though it is hard to believe that a European pension fund makes investment decisions on the basis of a fund's name. Funds with impact-related terms in their name – whether they are aiming for social or environmental impact, and whether or not they are badged as "Article 9" – will have to apply a new set of exclusionary screens that may not have been part of their original pitch to investors (and which some investors may not want).
It is also concerning that a number of uncertainties remain – including, for example, how funds that ramp up their investments during an investment period and then sell them during a harvesting period are supposed to apply the quantitative thresholds. Further clarificatory guidance seems inevitable.
Firms whose national regulators decide to adopt the rules will need to comply with them for new funds from the autumn, although there will be further six-month grace period for existing funds. For those, managers can choose to comply, or change the fund's name. Many will choose a name change, but that is not necessarily straightforward – and could provoke awkward conversations with investors who are not closely following the meandering path of European sustainability regulation.
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