The European Securities and Markets Authority
(“ESMA“) has published its Final Report
on the Guidelines on funds’ names using ESG or
sustainability-related terms (the
“Guidelines”). ESMA was provided with
the mandates to develop guidelines on unclear, unfair or misleading
fund names in the updated Alternative Investment Managers
Directive1 (“AIFMD“) and
UCITS Directive, which are now in force.
We cover here the funds that are intended to be in scope of the
Guidelines, what the Guidelines entail and their proposed
timing.
From the outset, we note that Member States must implement the
Guidelines and there is the potential that the approach to such
implementation may vary in terms of how embedded they are in
regulatory regimes and how strictly they may be applied.
Which funds are in scope?
All alternative investment funds
(“AIFs“) that are managed by EU
alternative investment fund managers
(“AIFMs“) alongside UCITS managed by
UCITS management companies are in scope. ESMA has estimated that
around 1,702 EU-domiciled AIFs will be affected by the new
rules.
The Guidelines do not directly address the applicability of
non-EU managers marketing funds in the EU under the AIFMD’s
national private placement regimes. However, we do note that the
mandate for ESMA to produce the Guidelines is in Article 23 of
AIFMD, which covers the disclosures needed for investors for both
EU AIFs and those marketed into the EU. Further clarity on this
position may be provided by local regulators in the Member States
as we cover under “Are the Guidelines mandatory?”
below.
What do the Guidelines require?
The Guidelines include thresholds for asset allocation and
exclusionary criteria that varies dependent on the ESG or
sustainability-related term used in the name. We have summarised
the Guidelines here:
*What are the additional recommendations for
“transition-related” or “impact-related” named
funds?
Funds using “transition-related” or
“impact-related” terms in their names should also ensure
that the investments used to meet the thresholds specified are on a
clear and measurable path to social or environmental transition or
are made with the objective to generate a positive and measurable
social or environmental impact alongside a financial return.
The aim is to create an additional qualifying link between the
strategy and fund name, ensuring there is a measurable dimension to
the strategy itself.
What is meant by “meaningfully” investing in
sustainable investments?
Previously ESMA had suggested a 50% threshold for sustainable
investments in the “sustainability-related” name
category, however, this has been replaced with
“meaningfully” investing in sustainable investments. ESMA
sets out that as the “sustainability-related” fund name
can apply to either (1) funds disclosing under Article 9
Sustainable Finance Disclosure Regulation
(“SFDR“); (2) funds disclosing under
Article 8 SFDR which in part invest in economic activities that
contribute to environmental or social sustainable investment
objectives; and (2) funds disclosing under the Taxonomy-Regulation,
that there should be flexibility and no firm threshold. However,
whatever the commitment is to sustainable investments, ESMA notes
that this should be met by financial products at all times. Asset
managers will need to consider carefully their judgement of what
“meaningfully” is.
What is meant by the “binding elements of the
investment strategy”?
As noted above, the threshold recommendations for asset
allocation refer to being linked to the “binding elements of
the investment strategy”. There is a requirement in the
mandatory templates of SFDR Article 8 and 9 pre-contractual
disclosures to commit to the binding elements of the ESG or
sustainability-related investment strategy. “Binding
elements” means those elements of the investment strategy that
apply to environmental and/or social characteristics promoted or
sustainable investment objective that cannot be overridden with
discretion and apply to the “whole holding
period”4.
Why does the exclusionary criteria vary dependent on the
fund name?
ESMA has taken the view that for funds using
“environmental-related” or “impact-related”
terms in their names, it is reasonable for investors to expect that
there would not be significant investments in fossil fuels and
therefore the PAB exclusionary criteria should be followed.
However, for the “transition”, “social” and
“governance” related fund names, ESMA has the view that
these categories should not penalise investment in companies
deriving part of their revenues from fossil fuels
— in the case of “social” and
“governance” related names any environmental
considerations may not be the focus and for “transition”
related names the strategy could be in investments fostering a path
to transition towards a greener economy, including those with
fossil fuels as part of their revenue base.
What kind of assets do the exclusionary criteria apply
to?
The exclusions apply to “companies” regardless of how
investment in those companies are made or which financial
instrument those companies may issue, for example, they cover
bothequity and debt investments. There is no guidance on whether
the Guidelines should be applied on a look-through basis for any
fund of funds or for any real assets or other non-investee company
asset classes.
What is the application of the Guidelines to
closed-ended funds?
ESMA noted the feedback that respondents had provided on
closed-ended funds, including that as they are no longer open for
distribution, they should have no need to adhere to the
naming-related provisions as they are not being marketed or sold to
investors. ESMA also details the feedback that respondents set out
there would be little rationale in applying the provisions, as it
would be seen as an inappropriate retroactive change.
However, despite the feedback, ESMA has sets out that the
Guidelines are intended to apply without distinction to either
open- and closed-ended funds. ESMA is of the view that it would be
“meaningful” to ensure that the name of the fund matches
with the underlying investments even for investors in a
closed-ended fund (including existing investors).
Whilst this initially appears far-reaching in scope, the capture
of closed-ended funds is not directly addressed in the Guidelines
themselves and it will be up to individual Member State regulators
as to how the Guidelines will be approached, as we set out under
“Are the Guidelines mandatory?”. We recommend that asset
managers with ESG or sustainability-related named closed-ended
funds keep a watching brief on the Member States’
implementation of the Guidelines for a firmer position on the
expectation for such funds.
Are the Guidelines mandatory?
Within two months of the date of publication of the Guidelines
on ESMA’s website in all EU official languages, the competent
authorities (local regulators) must notify ESMA whether they (i)
comply; (ii) do not comply but intend to comply; or (iii) do not
comply and do not intend to comply with the Guidelines. In case of
non-compliance, the competent authorities must also notify ESMA
within two months of the date of publication of the Guidelines the
reasons for non-compliance.
Local regulators are tasked with making every effort to comply
with the Guidelines and to incorporate them into their national
legal and/or supervisory frameworks and ensure through supervision
that financial market participants comply with the Guidelines.
However, the optionality of confirming compliance, the nature of
them being termed “Guidelines” and that scoping points
such as on closed-ended funds and non-EU AIFMs marketing into the
EU are not covered in the Guidelines themselves means there is a
watch and wait for how each Member State approaches the
implementation of the Guidelines. There could be a variety of
approaches to how deeply the Guidelines are embedded and how
broadly they are applied in regulatory regimes.
Nevertheless, for EU funds moving forwards with new ESG or
sustainability-related fund names, we do recommend that the
Guidelines are factored into strategy considerations.
What are the supervisory expectations?
There is a broad range of supervisory expectations set out in
the Guidelines, which may provide some reassurance to asset
managers on a proportionate approach being encouraged to be taken
by regulators in relation to the Guidelines. They include that a
temporary deviation from the threshold and exclusions should be
treated as a passive breach and corrected in the best interest of
the investors, provided it was not deliberate by the asset manager.
“Further investigation” and “supervisory
dialogue” is also recommended to be considered where:
- there are discrepancies in the level of the quantitative
threshold which are not passive breaches; - there is a fund that does not demonstrate sufficiently high
level of investments to use the transition-, ESG-, impact- or
sustainability-related terms in its name; or - where the competent authority considers that using transition-,
ESG-, impact- or sustainability-related terms in the fund name
would result in investors receiving unfair or unclear information
or in a failure of the manager to act honestly or fairly thus
misleading investors.
However, there is no specific enforcement action or penalties
recommended in the Guidelines.
How do these fund name Guidelines relate to any
categories introduced as part of SFDR 2.0?
SFDR is currently under consultation which we have reported on
most recently here, which has
sought feedback on the introduction of categories and a labelling
system funds. ESMA notes that “SFDR may take many years to
complete, while greenwashing risks in funds need to be addressed in
the present”. ESMA further sets out that it “supports
labels but these would require legislative changes and they will
require a long time to be implanted and will not help tackling the
issue at stake in an urgent manner”. This is potentially
useful insight into the timing of any SFDR developments and can be
read that the market must work with the current SFDR disclosure
regime and these additional Guidelines rather than expect any
imminent wholesale change with SFDR 2.0.
When do the Guidelines apply?
They will apply three months after the date of the publication
of the Guidelines on ESMA’s website in all EU official
languages. ESMA sets out that managers of any new funds created
after the date of the application of the Guidelines should apply
the Guidelines immediately in respect of those funds. For managers
of funds existing before the date of application of these
Guidelines they should apply the guidelines in respect of those
funds after six months from the application fate of the Guidelines
(nine months in total). However, as noted under “Are the
Guidelines mandatory?” there could be variations in approaches
to timing and scope under the individual Member State
implementation of the Guidelines.
What are the next steps?
We recommend that asset managers keep a watching brief when the
Guidelines are published in all EU official languages on the ESMA
website and the individual Member State implementation of the
Guidelines for clearer direction on how strictly the Guidelines
will be applied and how widely in terms of funds managed by non-EU
AIFMs and closed-ended funds.
For AIFs managed by EU AIFMs we do recommend that the Guidelines
are considered in strategy setting moving forwards where there
might be an ESG or sustainability-related name.
Footnotes
1 For our article on AIFMD II, please see: AIFMD 2.0 –
Evolution Rather than Revolution – Insights – Proskauer
Rose LLP
2 Article 12(1)(a)-(c) of Commission Delegated Regulation
(EU) 2020/1818
3 Article 12(1)(a)-(g) of Commission Delegated Regulation
(EU) 2020/1818
4 JC 2023 18 –
Consolidated JC SFDR Q&As (europa.eu) – Question 2
– Answer provided by the European Commission on the
interpretation of the SFDR, published on 14 July 2021 and Recital
11 of Commission Delegated Regulation (EU) 2022/1288
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
