Stockholm (NordSIP) – The name of financial products can seem like a superficial issue for sustainable investors. However, given limited time, resources and attention spans, the name of a fund is key to capture the attention of potential investors. But accuracy matters, lest fund providers use inaccurate but attention-grabbing names to fool investors.
To this end, regulators realised early on that the name of a sustainable fund – the very use of “sustainable” as an adjective in a fund’s name – should be properly regulated. As far back as October 2021, a mere seven months following the application of the EU’s Sustainable Finance Disclosures Regulation (SFDR), Nordic financial services authorities (FSAs) started looking into the fund names and the credibility of their implied sustainability claims.
In May 2024, the European Securities Market Authority (ESMA) published its initial guidelines on funds’ names using ESG or sustainability-related terms. Updated guidelines were issued at the end of August. These guidelines are published to support the practical implementation of Commission Delegated Regulation (CDR) (EU) 2020/1818 of 17 July 2020. The CDR supplements Regulation (EU) 2016/1011 of the European Parliament and of the Council as regards minimum standards for EU Climate Transition Benchmarks and EU Paris-aligned Benchmarks. The guidelines are expected to start to apply from 21 November 2024
Now, the European Fund and Asset Management Association (EFAMA) has argued that fund naming guidelines issued by ESMA, “create inconsistencies with other sustainable finance regulations”, which “put growth of corporate green bond sector at risk”. However the issue might not be so complicated.
Regulatory Inconsistencies?
“For instance, the EU Green Bond Standard (EU GBS) doesn’t restrict the eligibility of issuers and in particular does not exclude companies based on standards for Paris-aligned benchmarks (PAB). However, the new fund naming rules do exclude companies on this basis, regardless of the project they are financing with the bond,” EFAMA’s press release argues.
“Green bonds enable capital-raising and investment for projects with environmental benefits. The EU has seen significant growth of the green bond market and accounted for almost half the world’s green bonds last year. If the EU wants to remain competitive in this area and facilitate the financing of green projects in Europe and beyond, regulators and supervisors need to ensure rules like the fund naming guidelines don’t hinder this market or unnecessarily increase regulatory complexity for end-investors,” Tanguy van de Werve, EFAMA’s Director General, says.
Could Guidelines Lead to Divestments?
Contemplating these seeming contradictions, EFAMA argues that bond funds will be faced with the choice to do one of two things “This means that a bond fund investing in green bonds might have to change names if it does not restrict the eligibility of bond issuers. Alternatively, the said fund could keep its name and divest from all bonds by issuers who generate parts of their revenues from PAB-excluded activities.”
EFAMA argues that divestment would undermine the transition because “the largest corporate issuers are utility companies”, which if they were to be excluded “could raise their cost of capital, hinder key projects and slow down the energy transition.”
“In sustainable finance regulation, the general interpretation has been that the project being financed should be the focus, not the wider activities of the issuing company. This is particularly relevant when it comes to funding the energy transition. To ensure consistency across regulations, this principle should also be applied within the fund naming guidelines. Our hope is that ESMA will see the logic of this when it comes to green bonds. If Europe wants to remain a world leader in sustainable finance, consistent understanding and application of key concepts will be crucial,” Anyve Arakelijan, Regulatory Policy Advisor at EFAMA, adds.
Change the Name?
In its press release, EFAMA discusses only the implications of any potential divestment caused by the new fund naming guidelines, when the seemingly simpler solution of changing the fund name remains available. “A bond fund investing in green bonds might [indeed] have to change names if it does not restrict the eligibility of bond issuers.”
The assertion that “the new fund naming rules do exclude companies on this [standards for Paris-aligned benchmarks (PAB)] basis” also appears at odds with the guidelines issued by ESMA in May 2024.
Discussing the feedback it received, ESMA acknowledged that “consultation respondents criticised the ‘one size fits all’ approach by ESMA by requiring PAB exclusions for all ESG and sustainability-related terms in fund names. Respondents highlighted that since PAB exclusions include certain revenue-based fossil fuel companies, some transition focused strategies could not use appropriate terms in their names.” Recognising the validity of these concerns, “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.”
“Therefore, the exclusion criteria of the Climate Transition Benchmark (CTB) are instead provided for terms that are transition-, social- and governance-related. CTB exclusions refer to (a) companies involved in any activities related to controversial weapons, (b) companies involved in the cultivation and production of tobacco, and (c) companies that benchmark administrators find in violation of the United Nations Global Compact (UNGC) principles or the Organisation for Economic Cooperation and Development (OECD) Guidelines for Multinational Enterprises,” ESMA added in May.
“To further reflect the feedback related to transition terms, ESMA introduced a new category for transition-related terms. (…) the introduction of this category of terms is designed not to penalise investment in companies deriving part of their revenues from fossil fuels, thus promoting strategies aimed to foster a path to transition towards a greener economy.”
“The transition-related terms include words such as ‘improving’, ‘progress/ion’, ‘evolution’, ‘transformation’, and any related words. This would help catch a wide set of terms that give the impression of a positive evolution towards the goals described in the objectives,” ESMA continues.
ESMA’s guidelines would suggest a simple solution to the problem. Investors managing bond funds keen on supporting utility companies doing their share for the energy transition while also investing in pure play green bonds, can change the name of their funds from one that includes “green” to another that includes “transition-related terms”, such as those mentioned by ESMA.
