EU fund naming guidelines uncertainty investors

The ESG fund names guidelines(58 pages / 698 KB) introduce several critical requirements for funds that wish to use ESG-related terms in their names The move is part of a broader effort to combat greenwashing and ensure that investors are not misled by fund names that suggest a greater focus on sustainability than is actually the case. 

While these guidelines are voluntary, they are likely to drive sponsors away from using ESG related terms in fund names. In fact, the new guidelines will impact as many as 4,300 EU funds, according to Morningstar research. Of 2,500 fund names with stock holding data, the research found that more than 1,600 are exposed to at least one stock in breach of the Paris-Aligned Benchmark (PAB) or climate-transition requirements. The new guidelines will therefore impact a significant number, about two thirds of funds. These funds will now need to consider either divesting from their stocks or rebranding. 

The guidelines introduce several critical considerations, including the 80% threshold. This rule mandates that if a fund includes any ESG-related terms in its name, at least 80% of its assets must be invested in accordance with the environmental or social characteristics, or sustainability investment objectives, as disclosed in the fund’s investment strategy. Additionally, for funds that use terms derived from the word “sustainable”, a 50% threshold will apply. 

The introduction of these quantitative thresholds is one of the main challenges of the guidelines. Ultimately, there is no standardised user data, so fund managers will need to determine whether they can demonstrate compliance against arbitrary thresholds on an ongoing basis. Depending on which words you use, you may have both an 80% and 50% ratio to meet – this arguably adds a double layer, complex test for investors rather than adding any meaningful investor protections. 

The ESMA guidelines also categorise terms into six distinct types: transition, environmental, social, governance, impact, and sustainability. Each category has specific rules to ensure clarity and prevent misuse. 

Any fund using the word “transition” or “impact” in its name must ensure that investments used to meet the thresholds are clear and measurable against the social or environmental transition. Alternatively, funds must demonstrate that their investments are made with the objective to generate positive and measurable social or environmental impact alongside financial return. 

Environmental-related terms mean any words that may give investors the impression of promoting environmental characteristics including “green”, “environmental”, and “climate”. Sustainability-related terms include terms derived from the word, such as “sustainable”, with impact-related terms including “impactful” or “impacting”. The guidelines consider terms to be social-related if they risk giving investors the impression of promoting social characteristics, such as “equality”. Finally, governance-related terms include any words providing an impress of focus on governance, such as “controversies”.

All of the ESG terms and “transition” have non-exhaustive lists of examples. This creates potential issues for sponsors of funds that might use those words in differing contexts, such as “evolution”, which could relate to a purely economic transition –not a term that is reserved for the environment. 

There is further uncertainty for sponsors that may use terms that skirt those definitions, with the non-exhaustive lists also risking regulatory uncertainty.