ESG-related terms: a new circle of confusion

On 18 November 2022, the European Securities and Markets Authority (ESMA) published a consultation relating to proposed guidelines on the use of ESG and sustainability related terms in funds’ names.

The regulator hopes to address fairness, clarity and non-misleading concerns pertaining to marketing communications and greenwashing. Both UCITS and AIFs fall within the guidelines’ scope and no distinction is made between marketing towards retail and institutional investors.

However, a lack of definitions for the terms “ESG” and “impact” raises concerns about certainty against the backdrop of wider fragmentation of ESG frameworks and repeated calls from industry bodies for increased standardisation.

The proposal put forward two thresholds:

1. If a fund has any terms related to ESG or impact in its name, a minimum of 80% of its investments must meet the environmental, social or sustainable investment objectives as per the fund’s investment strategy.
2. Should a fund use the term ‘sustainable’ or derivative expressions, the minimum threshold above applies and an additional minimum of 50% of the 80% must qualify as sustainable investments under Article 2(17) of the SFDR.

While the second threshold makes reference to the SFDR’s definition of the term “sustainable”, the language of “ESG” and “impact” remains vague as no definitions or clarifications are provided. “As it stands, the absence of clear definitions raises questions as to the exact scope of the guidelines,” says Philip Bartram, partner at Travers Smith.

Contrastingly, the UK regulator published its own consultation paper earlier this year, including a list of proscribed terms. While non-exhaustive, it provides increased guidance compared with the ESMA’s current proposal.

Additionally, there seems to be a dissonance between the regulator’s guidelines and the practicalities of investing, as Bartram points out: “Under the proposed wording, thresholds will be tested against current assets. That is a challenge for close-ended funds. Many funds may not immediately meet the requirements, especially in early and late stages. While the draft guidelines include a transition period for funds launched prior the effective date, this remains problematic - particularly for close-ended funds.”

Finally, the paper refers certain enforcement powers to relevant national authorities, which has the potential to further fragment definitions by jurisdiction.

Next steps

February 20th 2023 has been indicated as the deadline for the consultation. Final legislation should follow in Q2 or Q3 of 2023. It will then become effective three months after publication on ESMA’s website.