ESMA Publishes Q&A on its Guidelines on Funds’ Names Using ESG or Sustainability-related Terms

Background

On 14 May 2024, ESMA¹ published its final report² containing guidelines for investment funds using ESG or sustainability-related terms in their names (the Guidelines).

The purpose 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.

The Guidelines started applying on 21 November 2024 (the Application Date). Any new funds created on or after the Application Date are expected to apply these Guidelines from launch. For funds existing before the Application Date, there is an additional six-month transition period, endingon 21 May 2025.

For full details of the requirements under the Guidelines, please refer to our OnPoint "ESMA Publishes Guidelines on Funds' Names Using ESG or Sustainability-Related Terms", available here and our OnPoint on the timing of the application of the Guidelines, available here.

ESMA Q&A

On 13 December 2024, ESMA published Q&As on aspects of the practical application of the Guidelines (the Q&A). The objective of the Q&A is to "ensure a smooth application of the Guidelines through common understanding of key concepts"³.

The Q&A, which cover both UCITS and AIFs and are identical apart from the reference number of the Q&As, relate to:

• Green bonds⁴ - As drafted, the Guidelines require that compliance with the Climate Transition Benchmark exclusions and the Paris-aligned Benchmark exclusions set out in respectively Article 12(1)(a)-(c)⁵ and Article 12(1)(a)-(g)⁶ of Commission Delegated Regulation 2020/1818 (the Benchmark Delegated Regulation)⁷ apply at an investee company level rather than a use of proceeds basis. In its response to this Q&A, ESMA confirms that investments in European Green Bonds that have been issued under the European Green Bonds Regulation⁸ do not need to be assessed against these exclusions as referred to in paragraphs 16-18 of the Guidelines. For any other type of use of proceeds instruments, including green bonds not issued under the European Green Bonds Regulation, the above referenced exclusions must be assessed on a look-through basis to the underlying economic activities financed by such instruments. This look-through approach is not, however, available for any investment in a company that is in violation of the United Nations Global Compact principles or the Organisation for Economic Cooperation and Development Guidelines for Multinational Enterprises.
• Investing "meaningfully" in "sustainable investments"⁹ - Under the Guidelines, funds using a "sustainable" term in their name are required to commit to invest meaningfully in sustainable investments within the meaning of Article 2(17) of the Sustainable Finance Disclosure Regulation (EU 2019/2088) (SFDR). There has been a lack of clarity in the market as to what level of investment constitutes "meaningfully" resulting in concerns that there will be a lack of harmonisation among that national competent authorities (NCAs) in enforcing the Guidelines.In the response to the Q&As, ESMA explains NCAs "may find" that funds investing less than 50% of its investments in sustainable investments are not "meaningfully investing in sustainable investments" and that the amount may be higher depending on the circumstances of the case. While this response provides a clear minimum target threshold, this threshold is not expressed as an absolute minimum (e.g. "may find") and provides flexibility for an NCA to set a higher threshold, a position that does not exactly address the issue of harmonisation.
• The definition of controversial weapons¹⁰ - Article 12 of the Benchmark Delegated Regulation, requires administrators of EU Paris-aligned Benchmarks to exclude companies "involved in any activities related to controversial weapons" from those benchmarks. ESMA refers NCAs (in the absence of anything in the Benchmark Delegated Regulation) to the list of controversial weapons provided in indicator 14 of Table 1 of Annex I of the regulatory technical standards to the SFDR (Commission Delegated Regulation (EU) 2022/1288) and clarifies that controversial weapons are "anti-personnel mines, cluster munitions, chemical weapons and biological weapons".

Conclusion

The Q&A provide helpful clarification on specific aspects of the Guidelines. Although the Guidelines and the Q&A are meant to assist in uniform application across the EU, the ability for NCAs to determine the minimum level of investing "meaningfully" in sustainable investments may lead to an unlevel playing field and possible regulatory arbitrage.