ESMA guidelines add to SFDR ‘complexity’ for fund sponsors

Mark Shaw of Pinsent Masons recommended the action after the European Securities and Markets Authority (ESMA) published finalised guidelines on funds’ names using ESG or sustainability-related terms (58-page / 698KB PDF).

Under the guidelines, funds must comply with strict criteria to use any ESG-related words in its name. Further conditions apply to using the word “sustainable” or any other term derived from the word “sustainable”, in a funds’ name, while restrictions have also been imposed on the use of the word “impact” or “impact investing” or any other impact-related term when marketing funds.

ESMA’s guidelines will begin to apply three months from the date they are published in all the languages of EU countries, though a further six-month transition period will apply for existing funds.

In relation to any ESG-related words, ESMA confirmed their use would only be permitted if a minimum proportion of at least 80% of its investments are used “to meet the environmental or social characteristics or sustainable investment objectives in accordance with the binding elements of the investment strategy” that funds must disclose under the EU’s Sustainable Finance Disclosure Regulation (SFDR).

To use the word, or any other term derived from the word, ‘sustainable’ specifically, ESMA had proposed a further requirement that at least half of the 80% minimum threshold requirement be made up of “sustainable investments”. ESMA has, however, dropped the secondary 50% requirement from its finalised guidelines. Instead, funds must demonstrate “a commitment to invest meaningfully in sustainable investments” to use any sustainability-related words in funds’ names.

A further change is that ESMA has drawn a distinction between terms used to describe a funds’ environmental credentials, and those used to describe their ‘social’ or ‘governance’ focus. The change is designed to ensure that funds using terms in their name that are not environmental or that focus on transition strategies do not fall subject to exclusions in EU climate benchmarks that cap what revenue companies seeking to rely on those benchmarks can derive from fossil fuels.

ESMA has introduced a new category of regulation to cover the use of energy transition-related terms, such as “improving”, “progression”, “transformation”. When using any “transition”-related word, fund managers will have to demonstrate that the investments are on a clear and measurable path to social or environmental transition.

Shaw, who recently attended the Association of the Luxembourg Fund Industry (ALFI) roadshow event in New York, said the challenges posed by the EU’s sustainable finance regime has been a hot topic for US sponsors, with these new rules adding an additional layer of regulatory risk.

“ESMA’s guidelines provide an additional layer of complexity to the SFDR regime, which industry and advisers in the EU are otherwise seeking to try to demystify – to encourage US sponsors to continue to raise capital in Europe,” Shaw said.

“While some of the quantitative thresholds have been relaxed, the rules have broad scope in terms of the words that are caught in relation to ESG, so sponsors should go through a careful review of existing fund names. There is a six-month transition period to allow for this, though there is also a three-month period implementation period before that is triggered,” he said.