The European Securities and Markets Authority (ESMA), the European Union’s markets regulator, announced on May 14, 2024, the publication of its final guidelines (the “Guidelines”) on the use of ESG and sustainability-related terms in investment fund names.

The Guidelines include required investment thresholds for sustainable investment funds and the creation of a transition category for investments that are not yet fully “green” but are making positive progress towards environmental sustainability goals.

According to ESMA, the rapidly increasing investor demand for ESG-focused funds has encouraged asset managers to use sustainability-related terms in fund names to attract investors, leading to an increased risk of greenwashing.

A recent study published by ESMA found a rapid increase in the use of sustainability-related terms in fund names in Europe in recent years, with the proportion of funds using ESG terms quadrupling over the past decade. Fund managers have been creating new ESG-related products and changing fund names to include sustainability-related terms.

The study also revealed that fund providers prefer more general ESG terms, which can make it difficult for investors to verify whether the investments align with the fund names.

The Guidelines follow a consultation launched by ESMA in November 2022 on the proposed guidance. In its initial proposal, ESMA set a threshold for the minimum proportion of investments required for the use of ESG-related fund names. It proposed an 80% threshold for the use of “ESG-related” words and a 50% threshold for the use of “sustainable” or any sustainability-related terms.

Additionally, ESMA suggested criteria based on the EU’s Paris-Aligned Benchmarks (PABs), which exclude fossil fuel companies and electricity producers with high greenhouse gas emissions, for such funds.

The different thresholds for “ESG” and “sustainability-related” terms were criticized by investor groups, who argued that investors often do not distinguish between these terms, potentially leading to confusion. Feedback also reflected demand for transition-related terms to support investment strategies promoting the shift to a greener economy.

In the Guidelines, ESMA removed the 50% sustainability-related threshold but maintained the requirement that funds using the term “sustainable” must meaningfully allocate at least 80% of their investments to sustainable investments.

ESMA’s final guidelines also include a transition category encompassing terms like “improvement,” “progress,” “evolution,” and “transition.” This category allows investments in companies deriving some revenue from fossil fuels, applying deductions from the EU’s Climate Transition Benchmarks (CTBs) instead of PABs while also including the 80% investment threshold.

The Guidelines will come into effect three months after being published on ESMA’s website in all EU languages.