21 May 2024

A quick guide to the ESMA's ESG Fund Name rule

The European Securities and Markets Authority (ESMA) has released its long-awaited final report on guidelines for investment funds using ESG or sustainability-related terms in their names. The report aims to combat greenwashing and ensure clarity for investors.

Here’s our quickfire take on what the report says.

Quantitative Thresholds Introduced

ESMA has introduced quantitative thresholds to assess the appropriateness of ESG-related terms in fund names. Funds using environmental, social, or governance-related terms must invest at least 80% of their assets by their disclosed ESG strategy.

Exclusion Criteria for Paris-Aligned Benchmarks

The guidelines require funds using ESG- or sustainability-related terms to adhere to exclusion criteria based on the Paris-Aligned Benchmarks (PAB) rules. These exclusions cover controversial weapons, tobacco, and companies violating UN Global Compact principles or OECD Guidelines for Multinational Enterprises.

Transition and Impact Funds Face Additional Requirements

Funds using “transition” or “impact” terms must demonstrate that their investments are on a clear and measurable path to social or environmental transition or generate positive, quantifiable impact alongside financial returns. This requirement ensures the credibility of these specialized funds.

Here are five key recommendations based on ESMA’s final report, along with the specific roles responsible for each task.

Timely Compliance for New and Existing Funds

Compliance officers and legal teams should prioritize adhering to the guidelines within the specified timeframes. Product development teams and fund managers must ensure new funds comply immediately upon the application date, while portfolio managers and investor relations professionals should work together to adjust existing funds within the six-month grace period.

Ongoing Monitoring of Quantitative Thresholds

Risk managers and compliance analysts must monitor funds’ adherence to the quantitative thresholds for ESG- or sustainability-related terms throughout the fund’s life. Financial reporting specialists should verify compliance through periodic disclosures and keep senior management informed of any deviations.

Managing Temporary Threshold Deviations

When temporary deviations from the quantitative thresholds occur, portfolio managers and risk analysts should treat these instances as passive breaches and take corrective action in the best interest of investors. Compliance officers must investigate deviations resulting from deliberate choices by the fund manager and report their findings to senior management.

Engaging in Supervisory Dialogue

Compliance officers, legal professionals, and senior management should be prepared to engage in supervisory dialogue with fund managers when discrepancies in threshold levels are not passive breaches, when funds fail to demonstrate sufficient ESG investments to justify their name, or when the use of ESG-related terms in the fund name misleads investors.

Aligning Index-Tracking Funds with Guidelines

Portfolio managers and product development teams managing funds that designate an index as a reference benchmark must ensure compliance with ESMA’s guidelines when using ESG- or sustainability-related terms in their names. Compliance officers and legal professionals should verify that these funds fulfill the relevant guidance to maintain compliance.

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