EU Cracks Down on ESG Investment Fund Names with New Greenwashing Rules

The EU’s corporate watchdog has finalised its guidelines on the requirements for investment funds to use environmental, social and corporate governance (ESG) in their names, in an effort to combat greenwashing.

The European Securities and Markets Authority, the securities agency of the EU, has published the finalised greenwashing guidelines for investment funds that use ESG or sustainability in their names. These include investment thresholds required for sustainable funds, and the establishment of a transition category for funds that aren’t yet green but on a positive path towards sustainability goals.

Under the long-awaited rules, if a fund has ESG or other impact-related terms in its name, at least 80% of its assets must meet ESG objectives outlined in the stated investment strategy. And if a fund is using the word ‘sustainable’, it should “meaningfully” be making sustainable investments at all times, in line with Parils-aligned benchmarks.

The rules come on the back of a study where the ESMA found a fourfold increase in the number of funds using ESG terms in the last decade, as asset managers launched ESG-related products and changed names to integrate green terms. Its analysis has shown that 9.6% of the total investment funds in the EU have ESG-related terms in their name.

“A fund’s name is often the first piece of fund information investors see and, while investors should go beyond the name itself and look closely at a fund’s underlying disclosures, a fund’s name can have a significant impact on their investment decision,” the regulator stated in its report.

“The purpose of these guidelines is to specify the circumstances where the fund names using ESG or sustainability-related terms are unfair, unclear or misleading,” the ESMA explained. “Misleading sustainability disclosures may give rise to risk of ‘greenwashing’. This is particularly relevant if funds are named as green or socially sustainable, when sufficient sustainability standards commensurate with that name have not been met.”

Protecting investors from bloated ESG claims

The new guidelines conclude a process that began in late 2022, after the rise in ESG fund names gave way to worries that some claims are misleading. A year earlier, the EU had introduced its Sustainable Finance Disclosure Regulation (SFDR). Around $13T of assets are now registered in the investing rulebook, but about 60% of these either say they promote ESG or make it an outright objective, according to Bloomberg Intelligence.

“The objective of the guidelines is to ensure that investors are protected against unsubstantiated or exaggerated sustainability claims in fund names, and to provide asset managers with clear and measurable criteria to assess their ability to use ESG or sustainability-related terms in fund names,” said the ESMA.

The original plan was to introduce a requirement for funds using sustainability-related terms to have at least 50% of their managed assets defined as sustainable under the SFDR. But the ESMA ditched this threshold in December, following concerns that this would provide fund managers with substantial leeway to define what is a sustainable asset, which could make it a meaningless guideline.

The regulator has also introduced a new category for transition-related terms (which also carry the 80% threshold), where it stipulated that the Climate Transition Benchmark’s exclusions should be applied. This will help avoid penalising investment in companies whose revenue is partly derived from fossil fuels, promoting strategies aimed towards a greener economy.

The rules will come into effect three months after the publication of the guidelines in all EU languages. From then, existing funds will have six months to comply, while any new funds should apply the rules immediately. Within two months, authorities in EU member states need to let the ESMA know if they’ve incorporated the guidelines in their supervision of the market or plan to do so – if they don’t intend to comply, they need to explain why.

The cost of complying with the EU’s greenwashing rules

Some have voiced their concern about the costs associated with the new ESG regulations. “This guidance could have a beneficial effect in terms of standardising practices in naming funds, as consistent requirements will be applicable in all EU member states, thus reducing the compliance costs over time,” stated the ESMA.

By introducing quantitative thresholds, regulators in EU countries may need to take further supervisory action to ensure compliance, but the watchdog doesn’t expect this to add significant costs. However, fund managers are anticipated to incur additional costs in order to meet the new criteria, as some may have to change their names, strategies and contractual documents.

In terms of what this monetary value may be, investment funds’ estimates vary from €20,000-30,000 to €60,000-100,000. “However, it is expected that the costs of compliance with the guidelines may be incurred only on a one-off basis after the application of these guidelines,” said the ESMA, “and only for existing funds.”

It added that compliance costs will be “largely compensated by the benefits for investors in terms of reduction of the greenwashing risk” – this will allow them to be more confident that fund names using ESG- or sustainability-related terms are “fair, clear and not misleading”.

The regulations are part of the EU’s ongoing crackdown on greenwashing. Its Empowering Consumers directive, for example, targets false information about a product’s main attributes (like durability, repairability, or recyclability), conditions under which companies can make future claims, and prohibits those that are insubstantial or irrelevant to consumers.

Meanwhile, the Green Claims Directive is focused on product labels and defines how environmental claims should be validated to prevent them from being misleading to consumers. This will be finalised in the next legislative term, which will begin after the EU Parliament elections next month.

The UK is introducing its own anti-greenwashing labelling rules at the end of this month, which mandates that any ESG references in products sold by investment firms must be clear and not misleading. In the US, the SEC enforced rules last September that require 80% of a fund’s portfolio to match the asset advertised in its name – although it has weakened its corporate disclosure rules for carbon emissions.