Travers Smith's Sustainability Insights: Greenwashing and the regulation of fund names in the EU

Travers Smith's Sustainability Insights: Greenwashing and the regulation of fund names in the EU

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A regular briefing for the alternative asset management industry. 

The EU may have blazed the trail in sustainability regulation, but European policymakers and regulators show no signs of relenting in their mission to stamp out "greenwashing". In financial markets there is a continuing concern that investors are being misled by firms that overstate the green credentials of their investment products.

While regulatory scrutiny and enforcement action are likely to increase, the European Commission has also acknowledged that a lack of clarity in the Sustainable Finance Disclosure Regime (SFDR) – a disclosure regime that is being used by many investors as a proxy for a labelling regime – itself "creates opportunities for greenwashing". In a recent speech, the Financial Services Commissioner confirmed that a consultation on the operation of the SFDR will be launched next year – only a few months after the detailed implementing rules become effective. That consultation will follow hard on the heels of, and will no doubt be informed by, a call for evidence on greenwashing that was launched in November by European supervisors. Industry responses to those requests for input will be vital, and it is particularly important that those running private funds make their voices heard.

In the meantime, Commissioner McGuinness has also repeated a pledge to publish "Q&As" on the SFDR to clarify how some of its most fundamental concepts should be understood. These are promised "early next year", approximately two years after the legislation first became effective. They follow "clarifications" on the SFDR secondary legislation, rules that are effective from January, published by the three pan-EU supervisors last month.  

Even if those clarifications bring some relief to the market, this legislation by executive "guidance" is hardly ideal. But it is an approach that is evident in a consultation on fund names – also focused on greenwashing, and also launched in November (a busy month for anyone trying to keep up with European sustainability rules).  

In summary, the consultation published by ESMA, the European Securities and Markets Authority, seeks comments on draft guidelines on the use of environmental, social or governance (ESG), or sustainability-related, terms in fund names. The effect is that use of such terms has an ongoing impact on portfolio composition and the fund's investible universe. (Our detailed briefing is here.)

Whether ESMA has the power to issue such "guidelines" in the absence of primary legislation on fund names is a matter for debate. ESMA justifies its intervention as elaborating on an EU asset manager's legal obligations to act honestly and fairly and to ensure that marketing communications are "fair, clear and not misleading". The guidelines would build on previous principles-based guidance on fund names issued in May 2022, but it is clear that ESMA's power to issue guidance does not give it the right to create new legal obligations for firms. These guidelines, which will apply to national regulators on a "comply or explain" basis, would, in effect, create new rules which would bind regulated EU firms.

That important concern might be less worrisome if the guidelines were less far-reaching and more clearly articulated.

But as well as being far-reaching, the guidelines are also vague – which would add to uncertainty in the market. 

Unlike the UK's similar proposals, which we discussed in a previous edition of Insights, the ESMA guidelines would not be confined to funds targeted at the retail market – they would also apply to institutional-only funds. There is no grandfathering for funds launched before the guidelines become effective (expected in mid to late 2023), and funds whose name breaches the guidance would have six months to change their name or their investment strategy. For many funds, particularly closed-ended ones, that is easier said than done, and market participants will no doubt ask for some carve-outs in their consultation responses.

But as well as being far-reaching, the guidelines are also vague – which would add to uncertainty in the market. The rules would apply to investment products with "ESG-related" or "impact-related" terms, or the word "sustainable" (or a derivative thereof) in their name – but there is no definition or exhaustive list of terms. That leaves market participants wondering which words will bring them into scope and which will not: for example, are "renewable energy", "forestry", "wildlife" and "water" ESG-related terms? There are undoubtedly many words that could be construed (at least by some) as having a connection with ESG or sustainability.

(Incidentally, the UK proposals are a little more helpful, although they too include a catch-all provision alongside a list of proscribed terms; namely, any other term which implies "sustainability characteristics".  Also noteworthy is that the UK FCA's proposals extend to the use of relevant terms in marketing materials, while ESMA's draft guidelines do not (yet) go beyond regulation of the name itself.)   

The ESMA guidelines would impose minimum quantitative thresholds on funds that use ESG-related terms in their name, with stricter thresholds for those including the word "sustainable" (or its derivatives).  However, the thresholds adopt concepts from the SFDR, which themselves remain very unclear. 

Managers of blind pool, closed-ended private funds will be wondering at which point they need to comply with the quantitative thresholds – and how compliance should be calculated, given that asset values vary and investments are often highly illiquid. This could be a major issue for private equity and similar fund managers.

There is also a "recommendation" that all funds which have an ESG or sustainability-related term in their name include a long list of exclusions from their investible universe, including those that "significantly" harm an environmental objective. In addition to these rules, funds using the term "impact" (or related words) in their name must also ensure that investments are made with the intention to generate positive, measurable social or environmental impact alongside a financial return. 

Although still a consultation draft, asset managers launching products in the coming year should take careful note of these proposals, and those in the UK – and may want to give comments to ESMA and the FCA before their respective early 2023 deadlines. And, while the guidelines would currently only apply to products marketed by EU-regulated asset managers, non-EU firms will be concerned that, in time, similar rules or standards will be applied to their products when marketed to EU investors.


Alternative and Sustainability Insights will take a break and return in January. We wish all our readers a happy and relaxing holiday season.

Read previous issues of Travers Smith's Alternative and Sustainability Insights

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