EU: ESMA confirms ESG and sustainability fund naming rules

ETFs using the term ESG or sustainable in their name must have at least 80% of investments tied to environmental or social characteristics, according to the EU’s new fund naming rules.

The European Securities and Market Authority’s (ESMA) final guidelines, published on 14 May, said funds using those terms must also adhere to the Paris-Aligned Benchmark (PAB) exclusion metrics, meaning no fossil fuel companies can be included.

This is also the case for funds using the term ‘impact’ or ‘impact investing’, the regulator said.

“We can expect many funds to change names,” Hortense Bioy, global director of sustainability research at Morningstar said..

“Those using ESG or sustainability terms in their names will be required to divest from fossil fuel companies.”

However, funds following transition strategies would not be required to use PAB exclusions, instead opting for Climate Transition Benchmark (CTB) exclusions, meaning they can invest in companies deriving part of their revenues from fossil fuels.

“ESMA has recognised that the fossil fuel exclusions in PAB could unnecessarily penalise some funds using terms in their name that are not environmental or that focus on transition strategies,” it said.

The regular introduced a new category for transition-related terms including words such as ‘improving’, ‘progress’, ‘evolution’ and ‘transformation’.

Funds using ‘social’ and ‘governance’ will also be tied to the CTB metrics.

“The rationale behind this proposal is that funds with social or governance terms in their names promoting social characteristics or objectives (or focusing on governance) could be too restricted in their investment universe by fossil fuel exclusions,” it said.

It comes after ESMA launched a call for evidence on ESG fund naming rules in November 2022 as it bids to stamp out greenwashing and protect investors.

Last December, ESMA abandoned its threshold of 50% for funds using sustainability-related words in their fund names after asset managers raised concerns it could amplify the risk of greenwashing.

The issue was particularly important for ETFs which are required to stick to strict naming conventions.

ESMA said existing funds will have roughly six months to adhere to the new rules when they come into force in three months, giving asset months roughly nine months to adjust the guidelines.