ESMA published on 18 November 2022 a Consultation Paper on Guidelines on funds’ names using ESG or sustainability-related terms (the “ESMA Guidelines”) in order to prevent greenwashing risk. These may, potentially, have massive implications for private equity fund managers.
Greenwashing Risk & Fund Names
Investors are allocating an ever-increasing proportion of their portfolios towards ESG strategies and may reasonably expect funds with these names to invest in companies with policies, practices, or characteristics that are consistent with ESG standards. The proposed ESMA Guidelines seek to regulate funds’ names to further help to prevent potential greenwashing risk in fund names. They are applicable to alternative investment fund managers and UCITS management companies and are relevant to all fund documentation and marketing communications addressed to (potential) investors of UCITS and AIFs. The ESMA Guidelines specify criteria in terms of quantitative thresholds to assess whether the name of a fund containing terms, acronyms or abbreviations suggesting that the fund focuses on investments that have, or investments whose issuers have, ESG or sustainability features, are fair, clear and not misleading.
Rules applying to Funds’ Names using ESG or Sustainability-related Terms
In accordance with the ESMA Guidelines, ESG- and sustainability-related terminology in fund names are proposed to be used only if the following (proposed) minimum quantitative thresholds are being complied with:
- 80% minimum proportion: if a fund has any ESG-related or impact-related word in its name, a minimum proportion of 80% of its investments should be used to meet the environmental or social characteristics or sustainable investment objectives in accordance with the binding elements of the fund’s investment strategy, which are disclosed in Annexes II and III of Commission Delegated Regulation (EU) 2022/1288 (“SFDR RTS”);
- Additional 50% sustainable investments threshold: if a fund has the word “sustainable” or any other term derived from the word “sustainable” (e.g. “sustainably” or “sustainability), it should allocate within the 80% of investments to “meet the environmental or social characteristics or sustainable investment objectives” (as above) to ensure that, at least, 50% of that 80% qualify as sustainable investments within the meaning of Article 2(17) Regulation (EU) 2019/2088, as amended (“SFDR”).
For funds that use the word “impact” or “impact investing” or any other impact-related term investments under the above-mentioned minimum proportions must, additionally, be made with the “intention to generate positive, measurable social or environmental impact alongside a financial return”.
ESMA also recommends the introduction of “minimum safeguards” that contain “exclusion criteria’ for all funds that which have an ESG or sustainability-related term in their name.
Unhelpfully, the proposed ESMA Guidelines do not define any of “ESG” funds’ names terms. ESMA, however, tried to give some degree of certainty by providing examples of fund names, such as “Climate Change Solutions Fund”, and how they are to be assessed. However, the examples are “vanilla examples” and limited. They still leave a degree of uncertainty for managers when assessing what funds’ names are caught and what (additional) requirements are applicable to the funds with those names.
Outlook: A Potential Minefield for Private Equity Fund Managers ?
If adopted in current form, the ESMA Guidelines could be a “potential minefield” for private equity fund managers. Albeit the greenwashing objective behind its potential adoption is to be welcomed, its scope seems to leave open too much room for interpretation. For example, the mere use of five (non-exhaustive) examples to clarify the terms “ESG-”, “impact-related” and “sustainability” in funds’ names seems to be vague and imprecise, whereas it would have potential massive implications in the market in terms of compliance efforts. In the context of the current uncertainties relating to the SFDR, it is clear that the ESMA Guidelines form part of a dynamic EU ESG regulatory framework that continues to evolve.