Worldwide - Fund Management/ REITs - ESG And EU Fund Names: ESMA's Final Guidelines

On 14 May 2024, the European Securities and Markets Authority (ESMA) published its final guidelines ESMA34-472-440 Final Report on the Guidelines on funds names (europa.eu) on the use of ESG- or sustainability-related terms in funds' names (Guidelines). ESMA issued the Guidelines under new mandates stemming from the revisions to the Alternative Investment Fund Managers Directive (AIFMD), which came into force on 15 April 2024 and on which we commented in our recent alert End of the Beginning: AIFMD II's Final Text.

The Guidelines broadly align with ESMA's December 2023 update, noted in our previous alert. ESMA has, however, abandoned the 50% minimum 'sustainable investment' threshold, which it had originally proposed in its November 2022 consultation. Instead, a minimum of 80% of investments will be required to meet the environmental or social characteristics or the sustainable investment objectives for terms covered by the Guidelines that are used in fund names. Also of note is the Guidelines' recognition of and rules for transition-related terms.

Timing

The Guidelines will come into force three months after they are published (following translation). Managers of existing funds will have a six-month period in which to comply (i.e., nine months from publication), whilst the Guidelines will apply to new funds immediately following publication.

Application to Non-EU Managers?

The Guidelines apply to provisions of the AIFMD, Recast UCITS Directive 2009, and EU Cross-Border Distribution Regulation 2019, which are only binding for managers established in the EU.

It is unclear whether individual EU member states will require non-EU managers to comply with the contents of the Guidelines through individual member state measures, especially where a non-EU manager has to apply for the approval of a private placement memorandum or other marketing materials with a member state national competent authority (NCA).

Fair, Clear, and Not Misleading: The Guidelines' Focus

ESMA states: 'A fund's name is often the first piece of fund information investors see and, while investors should go beyond the name itself and look closely at a fund's underlying disclosures, a fund's name can have a significant impact on their investment decisions.' The Guidelines are intended to tackle greenwashing risk in funds by using quantitative thresholds for the use of ESG and sustainability-related terminology in fund names. This is to ensure, in turn, that marketing communications are fair, clear, and not misleading and that fund managers are acting honestly and fairly. As well as having an impact on interoperability (discussed below), the Guidelines will be relevant to the following, covered in our recent Horizon Scan:

AIFMD2 (from which the Guidelines flow), having been made under an AIFMD2 (and UCITS Directive) mandate
The European Commission consultation on revisions to the Sustainable Finance Disclosure Regulations 2019 (SFDR), addressing marketing communications, product names, and whether or not the SFDR should include additional rules on labelling and marketing communications

The Guidelines — An Overview and Practical Points

The table below outlines the key obligations relating to the ESG- or sustainability-related terms AIFMs use in funds' names, along with our comments on each.

Term used in fund name	Requirements	Comments
Sustainability-related	Apply a minimum proportion of at least 80% of its investments to meet environmental or social characteristics or sustainable investment objectives Apply the exclusions for the EU Paris-aligned Benchmark (PAB) Invest 'meaningfully' in 'sustainable investments' (as defined in Article 2(17) of SFDR)	The PAB exclusions include certain investments deriving part of their revenues from fossil fuels.¹ 'Meaningfully' is not defined, but the previously-used 50% threshold could be a useful reference point.
Transition (terms include 'improve', 'progress', and 'evolution')	On a clear and measurable path to social or environmental transition Apply a minimum proportion of at least 80% of its investments to meet environmental or social characteristics or sustainable investment objectives Apply the exclusions for the EU Climate Transition Benchmark (CTB)	Notably, the CTB² exclusions are a shorter list (relating broadly to activities in controversial weapons or tobacco and activities in violation of UNGC principles or OECD guidelines) and do not extend to the fossil fuels exclusions. ESMA has provided this light-touch approach to encourage promotion of strategies aimed to foster the transition to a greener economy.
Impact	Made with the objective to generate a positive and measurable environmental or social impact alongside a financial return Apply a minimum proportion of at least 80% of its investments to meet environmental or social characteristics or sustainable investment objectives Apply the PAB exclusions	Alongside funds using environmental and sustainability-related terms in their names, the more onerous PAB exclusions apply to funds using impact-related terms in their names.
Environmental (terms include green', 'climate', and any ESG and SRI (socially responsible investment) abbreviations	Apply a minimum proportion of at least 80% of its investments to meet environmental or social characteristics or sustainable investment objectives Apply the PAB exclusions	See above.
Social or governance	Apply a minimum proportion of at least 80% of its investments to meet environmental or social characteristics or sustainable investment objectives Apply the CTB exclusions	'Social' means giving the investor any impression of the promotion of social characteristics (e.g., equality). Governance terms include 'controversies'.
Mix of the above terms	The above rules apply on a cumulative basis (except for funds with environmental and transition terms, for which only the CTB exclusions apply) 'Sustainable' terms always imply sustainability, irrespective of other terms used

Comparing the Guidelines with Other Regimes

The policy underpinning the Guidelines reflects current developments in countries such as the UK and the US and the rules governing fund names noted in our recent alert. We have set out in the table below some of the key points to compare and contrast the EU, UK and US fund names rules.

EU: ESMA Guidelines (in its Final Report)	UK: Sustainability Disclosure Requirements rules on naming and marketing	US: SEC amendments to Fund Names Rules (see our recent alert for more)
Come into force three months following publication (once translated)	Apply from 2 December 2024	Funds to comply by 11 December 2025 for funds with $1 billion or more in net assets; small fund groups have an additional six months to comply
Managers of existing funds: six-month transition period Managers of new funds: comply immediately	No transitional period	Staggered implementation (as set out above)
No exemption for funds no longer marketing or that are only open to professional investors	Only applies to communications and disclosure to retail investors	No exemption for funds no longer marketing or that are only open to professional investors
80% threshold related to the investments used to meet environmental or social characteristics or sustainable investment objectives	70% threshold of investments have environmental or social characteristics	80% of assets in a fund with a name that suggests a particular focus, including a name indicating that the fund's investment decisions incorporate ESG factors, must be invested in accordance with such focus
Funds with 'impact' in their name must have an objective to generate a positive and measurable environmental or social impact alongside a financial return	Cannot use 'sustainable', 'sustainability', or 'impact' unless using the 'Sustainability Impact' FCA label	N/A

Regulatory supervisory expectations

The Guidelines require NCAs to notify ESMA within two months of publication of the Guidelines to confirm whether or not they have incorporated the Guidelines in their national frameworks.

NCAs are expected to treat temporary deviation from the thresholds and exclusions as passive breaches by an AIFM — unless the AIFM has acted deliberately, which the AIFM must correct. ESMA encourages the NCAs to proactively investigate in certain circumstances (e.g., discrepancies in the level of the quantitative threshold that are not passive breaches), by scrutiny of the AIFM's periodic SFDR reporting.

Footnotes

1. The PAB exclusions prohibit investments in companies: (a) involved in any activities related to controversial weapons (as referred to in international treaties and conventions, UN principles and where applicable, national legislation); (b) involved in the cultivation and production of tobacco; (c) that benchmark administrations find in violation of the United Nations Global Compact (UNCG) principles or the OECD Guidelines for Multinational Enterprises; (d) that derive 1% or more of their revenues from exploration, mining, extraction, distribution or refining of hard coal and lignite; (e) that derive 10% or more of their revenues from the exploration, extraction, distribution or refining of oil fuels; (f) that derive 50% or more of their revenues from the exploration, extraction, manufacturing or distribution of gaseous fuels; or (g) that derive 50% or more of their revenues from electricity generation with a GHG intensity of more than 100g CO2 e/kWh.

2. The CTB exclusions are those prohibitions listed in (a)-(c) inclusive in the PAB list (set out above)

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ESG And EU Fund Names: ESMA's Final Guidelines

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