ESG names and claims in the EU UCITS fund industry: ESMA report

On 2 October 2023, the European Securities and Markets Authority (ESMA) published a trends, risks and vulnerabilities (TRV) risk analysis report on ESG names and claims in the EU fund industry (the report). While undoubtedly of interest, it should be noted that this is not the reply to ESMA's 2022 fund names consultation – we are still waiting for that (see below for details).

In preparing a primarily statistical Report, the ESMA authors analysed historical data drawn from a wide variety of retail EU UCITS fund and non-fund sources in order to conduct an assessment of how such funds have been using ESG-related words and phrases in regulatory documentation, marketing material and in the names of the funds themselves. The findings, broadly, were that such retail funds are increasingly using ESG-related language in their names and that investors have a preference for funds with ESG-related names.

Now Reading

What is the nature of the Report?

There are four significant points to note about the Report at the outset:

It is not a reply to the ESMA fund names consultation: The Report is not ESMA's response to its November 2022 consultation on draft guidelines relating to the use of ESG or sustainability related terms in funds' names (Consultation) (see our briefing on this) - a response is still awaited. That said, the Report is clearly not published in a vacuum and ESMA notes that the Report's findings demonstrate "the usefulness of ESMA's … public consultation on guidelines to ensure fund names accurately reflect their portfolio". Whether, and to what extent, those findings influence the nature and shape of ESMA's eventual response to the Consultation on fund's names remains to be seen.
It is focused on EU UCITS only: The report is a statistical analysis of fund names used in 36,000 EU UCITS funds between mid-2013 and mid-2023 (the sample therefore includes UCITS domiciled in the UK before the UK exited the EU on 31 December 2020). ESMA focused on UCITS funds because of the size of the market and the fact that such funds are open to retail investors. No AIFs were therefore subject to the analysis. This contrasts with the 2022 Consultation on fund names: the guidelines, at least as proposed, would apply to both UCITS and AIFs (including where they are set up as EuVECAs, EuSEFs and ELTIFs) and would capture funds irrespective of whether they are directed at retail investors or purely institutional investors.
It does not contain any recommendations: The Report is prepared in the light of ESMA's obligation (under the Regulation that established it) to monitor and assess market developments. As the copyright note indicates, the information contained in the publication "exclusively serves analytical purposes" and does not "prejudice, preclude or influence in any way past, existing or future regulatory or supervisory obligations by market participants". Because of this statistical, evidence-finding and analytical nature the report does not contain any policy recommendations as such, though, as seen below, the authors do make several observations during the course of presenting their findings.
ESMA continues to be motivated by concerns about greenwashing: The Report cites academic literature indicating that fund names can "misinform investors" if not aligned with the actual investment style of a fund. Tackling greenwashing is described as one of the key priorities of ESMA's broader Strategy on Sustainable

Identifying ESG terms

In order to establish a common reference point for ESG-related language in fund names and documents, ESMA first set about constructing a list of ESG terms and phrases from a variety of sources (many of which were not funds based) – for instance, US regulatory filing (10-K) reports, start-up companies, the UN Sustainable Development Goals, specific words used in SFDR and/or the Taxonomy Regulation and phrases used in the media. From that reference point, ESMA proceeded to compile a fund name-specific list of ESG terms, based on an analysis of 29,000 EU UCITS funds' names and documents and a broader ESG text list.

As regards the fund-specific list, words and phrases identified by ESMA as being ESG related include: "water waste", "net zero", "carbon reduction"; "green social", "cleaner living"; "ESG", "better world", "global impact"; "equality", "empowerment", "humanity"; "gender equality", "human capital". It will be seen that many of these terms are widely drawn (and are not necessarily particularly scientific). Given that the November 2022 Consultation fell short of exhaustively defining which terms ESMA considered to be "ESG-related", "impact-related" or "sustainable" (or a derivative thereof) some, many or all of the terms listed in the Report may gain traction for the purposes of developing final guidelines or specific naming rules. If this is the case, it may be that the eventual list of "ESG-related" terms is far broader than many in the market may have originally anticipated.

In addition, the longer, non-funds specific list (which ESMA says reflects ESG terms that are not actively used in fund names) nonetheless contains many terms that already are, or will likely become, sensitive in the context of a fund name: e.g., "climate change", "sustainable development" and "biodiversity".

The key findings

The key findings of the Report in relation to fund names and the use of ESG terms in fund documents were:

The "large majority" of SFDR Article 9 UCITS funds sampled included ESG-related words in their names.
One third of SFDR Article 8 funds also used ESG-related language in their names.
EU UCITS funds began to change their names to include ESG-related words in 2016, soon after the Paris Agreement.
There had been an "exponential" increase in the use of "general" ESG-related words in fund names, but the use of more specific environmental words or phrases (such as net zero or carbon) had only become slightly more prevalent.
The use of social-related words has "changed little" since 2013.
There was a sharp growth in the number of UCITS changing their names to include ESG-related terms during H2 2021/H1 2022, although this has subsequently slowed considerably.
In descriptions of investment strategies, usage of ESG terms was relatively low (23%).
ESG terms were far more prevalent in KIDs/KIIDs (80%).
Marketing materials usually included ESG-related terms (90%).

The "incidental" observations

In the commentary on the approach to the analysis and on the findings, the authors make a number of observations, none of which is, by itself, particularly contentious but which touch on issues which may be relevant in the Commission's ongoing review of SFDR. These observations include the following:

There is currently no EU regulatory definition of an ESG investment product, or an EU ESG label.
In the absence of EU ESG labels, some asset managers have begun referring to an Article 8 or Article 9 SFDR designation as a "proxy" ESG label: ESMA note that this "misuse of legislation can lead to confusion among investors as to whether a fund is ESG or not … reinforcing concerns over potential greenwashing".
The name of a fund is a "powerful marketing tool" and is arguably the first piece of information that fund investors receive (i.e. well before the KIID).
The misleading use of ESG terminology in a fund's name is a possible example of greenwashing – tackling greenwashing is one of ESMA's key priorities.

If you would like further information on ESMA's Report, or how it fits into wider considerations on the use of fund names, including those of AIFs, please speak to your usual Travers Smith contact or any of the individuals below

Read Tim Lewis Profile