ESMA Guidelines on Fund Names

Broadly, each category must meet separate recommendations in relation to (i) a minimum 80% threshold linked to the proportion of investments used to meet environmental or social characteristics or sustainable investment objectives, and (ii) the types of investments that must be actively excluded from the fund. There are some additional requirements in respect of specific types of funds.

The categories are as follows:

• Funds using sustainability-related terms.
  
  
• Funds using environmental- or impact-related terms.
  
  
• Funds using transition-, social- and governance-related terms.

The final Guidelines follow the November 2022 consultation and differ from those draft guidelines in a number of important respects including the replacement of two quantitative thresholds with a single one, revised and new categories, adjustments to some of the criteria and new definitions.  Most of these changes were trailed in outline in the follow up Public Statement in December 2023.  Unfortunately, however, many of the requests for clarification from industry associations were not met and therefore some key uncertainties remain (including how the quantitative portfolio composition thresholds apply to blind pool or closed-ended funds during a ramp-up or wind down period). 

In particular, the definitions provided in the Guidelines for assessing whether a term falls within a category are expressed to be non-exhaustive and therefore it is possible that regulators will also consider other words with similar meanings to fall within these definitions.  This could be particularly problematic in the case for terms relating to environmental, transition, social and governance characteristics where the test is whether the fund name used gives "the investor any impression of the promotion of" the relevant characteristics.  Firms will therefore need to think beyond the examples provided in the definitions and consider carefully the terms that they use in their fund names – they will have to be keenly aware of how a name might be perceived by investors and regulators.  The consultation version also included an Annex with worked examples; this has been deleted.

The Guidelines apply three months after the date of the publication of the guidelines on ESMA’s website in all EU official languages.  They will apply to new funds immediately after the expiration of that three-month period. However, pre-existing funds will have an additional six months to comply, effectively giving managers nine months to bring their investments in line with the Guidelines or change the name of their fund(s) so as not to include the offending term(s). For many funds, particularly closed-ended ones, that will be easier said than done. Disappointingly, no grandfathering provisions for fully-closed funds have been included – this was a key industry ask. 

In due course, further consultations on other types of fund names are expected.

We set out below some more details on the key recommendations in the Guidelines in relation to the three categories of funds.

The most stringent recommendations apply to funds using sustainability-related terms.  "Sustainability"-related terms, for these purposes, means any terms only derived from the base word "sustainable" such as "sustainably".

Funds using sustainability-related terms must:

• meet a threshold of at least 80% in terms of the proportion of investments used to meet environmental/social characteristics or sustainable investment objectives in accordance with the binding elements of the fund's investment strategy;
  
  
• not invest in any companies excluded under the Paris Aligned Benchmark (i.e. the full list in Article 12(1) of the Delegated Benchmark Regulation, which sets out those types of companies that administrators of EU Paris-aligned Benchmarks must exclude from such benchmarks (such as those with activities related to controversial weapons, tobacco and fossil fuels)); and
  
  
• commit to invest meaningfully in “sustainable investments” (as defined in the Sustainable Finance Disclosure Regulation (SFDR) - this commitment replaces a second quantitative threshold that had been in the consultation for at least 50% of investments to be "sustainable investments" as defined under SFDR).

The Guidelines now include a distinction between "environmental" and "social and governance" with a new category for funds using environmental- or impact-related terms.  

"Environmental"-related terms mean any words giving the investor any impression of the promotion of environmental characteristics.  The Guidelines state that this could include “green”, “environmental” and “climate” as well as the abbreviations “ESG” and “SRI”.   The list of words provided is non-exhaustive.

"Impact"-related terms mean any terms derived from the base word "impact" such as "impactful".

Funds using environmental- or impact-related terms must:

• meet a threshold of at least 80% in terms of the proportion of investments used to meet environmental/social characteristics or sustainable investment objectives in accordance with the binding elements of the fund's investment strategy; and
  
  
• not invest in any companies excluded under the Paris Aligned Benchmark (i.e. the full list in Article 12(1) of the Delegated Benchmark Regulation, (see above) (such as those with activities related to controversial weapons, tobacco and fossil fuels)).

If a fund uses an impact-related term in its name, it must also ensure that the investments used to meet the 80% threshold "are made with the objective to generate a positive and measurable social or environmental impact alongside a financial return".

A new category has been included for funds using transition-, social- and governance-related terms in their names.   This reflects feedback to the consultation and will be important for many firms.

This category applies a slightly lighter touch approach to reflect the fact that such funds may be investing in companies which have transition strategies but which currently derive part of their revenues from fossil fuels or which are focussed on social or governance objectives and therefore their investment in fossil fuels is not relevant.  Therefore, rather than applying the full list of exclusions under the Paris-aligned Benchmark as a minimum safeguard, only a subset of these exclusions – referred to as the Climate Transition Benchmark – are applied.  These are limited to companies with activities related to controversial weapons or tobacco or which are in violation of the UN Global Compact principles or the OECD Guidelines for Multinational Enterprises. 

"Transition"-related terms mean any terms derived from the base word “transition” such as “transitioning” as well as terms deriving from other words such as “improve”, “progress”, “evolution”, “transformation” and “net-zero”.  Again, the list of words provided is non-exhaustive and according to ESMA is intended to “catch a wide set of terms which give the impression of a positive evolution towards the goals described in the objectives”.

“Social”-related terms mean any words giving the investor any impression of the promotion of social characteristics such as “equality”.

“Governance”-related terms mean any words giving the investor any impression of a focus on governance such as "governance" or “controversies”.

Funds using transition-, social- and governance-related terms must:

• meet a threshold of at least 80% in terms of the proportion of investments used to meet environmental/social characteristics or sustainable investment objectives in accordance with binding elements of the fund's investment strategy; and
  
  
• not invest in companies excluded under the Climate Transition Benchmark (i.e. the first three types of company listed in Article 12(1) of the Delegated Benchmark Regulation, with activities related to controversial weapons or tobacco or which are in violation of the UN Global Compact principles or the OECD Guidelines for Multinational Enterprises).

If the fund uses a transition-related term in its name, it must also ensure that the investments used to meet the 80% threshold "are on a clear and measurable path to social or environmental transition". No further guidance is provided on what this means but, as a minimum, managers with funds in this category should consider processes to assess that investments meet the requirement.

Fund names combining more than one term

Where a fund name combines one or more terms related to transition, social and governance with one or more environmental- or impact-related terms (such as environmental and social), the requirements for those terms apply cumulatively. 

However, where a transition-related term is used in conjunction with another term, only the requirements for funds using transition-related terms apply unless the other term is a sustainability-related term.  

Where a term is used in combination with a sustainability-related term, the full sustainability-related requirements will continue to apply. 

Breach of the requirements

Inadvertent temporary breaches of the thresholds or the exclusions will be treated as a "passive breach" and should be corrected in the best interests of investors. 

Deliberate breaches may lead to action by the relevant regulator. Despite the fact that the Guidelines are intended to establish a degree of harmonisation in relation to addressing the risk of greenwashing, individual competent authorities will retain a good deal of autonomy e.g. in terms of assessing whether a breach is passive or deliberate and in relation to what supervisory action to take.

Fund managers (and internally-managed AIFs) should be considering the names of their funds in light of the Guidelines.  This includes any names which are not listed by ESMA but which might give investors the impression that they have environmental, transition, social and/or governance meanings.  Firms will therefore need to think beyond the examples provided in the Guidelines and consider carefully the terms that they use in their fund names.   If changes to fund names are required, this may require investor consent and/or updated notifications and disclosures and firms should start considering the Guidelines in good time to allow them to take any necessary action. 

If you would like further information or assistance in understanding the Guidelines, please speak to your usual Travers Smith contact or any of the individuals below.