EU Names Rules a Stop-gap Solution to Greenwashing
Transition of Sustainable Finance Disclosure Regulation to a labelling regime will be ongoing and multi-faceted.
Incoming rules from the European Securities and Markets Authority (ESMA) are expected to serve as an interim anti-greenwashing measure ahead of a deeper – and potentially multi-stage – update to the Sustainable Finance Disclosure Regulation (SFDR).
New regulations on the proportion of sustainable assets in green funds will be the first in a series of changes facing asset managers aimed at improving transparency and consistency, experts say.
ESMA’s fund name guidelines will ensure funds invest at least 80% of their assets in line with sustainability-related terms in their name – such as ‘ESG’ or ‘transition’. New funds will have to comply with the rules from 21 November, while existing funds have until May 2025.
These rules were introduced in the wake of a consultation seeking feedback on the current requirements of SFDR, which asked whether its Article 8 and 9 disclosure categories should be more formally established as fund labels. Market participants were also asked whether new labels should be introduced which align more closely with the UK’s Sustainability Disclosure Requirements (SDR).
Market opinion was evenly split and a decision on which direction SFDR will take has not yet been made by the European Commission. Further consultations on aspects of SFDR are expected.
“The ESMA fund names rules are a good first step for the SFDR review to build on,” Pierre Garrault, Senior Policy Adviser at the European Sustainable Investment Forum (Eurosif), told ESG Investor.
“We expect the SFDR review to be published next year, meaning a revised SFDR would be applicable by 2028 at the earliest – that leaves three or four years where updated rules will not apply. With that in mind, applying ESMA’s guidelines now will help to more immediately improve the current situation for end-investors regarding what is sold as Article 8 and 9 products.”
Vincent Vandeloise, Senior Research and Advocacy Officer at European NGO Finance Watch, said the ESMA rules will serve as an effective safeguard.
“But they should only be a temporary measure until they [the commission] can formally embed the naming rules within SFDR,” Vandeloise said.
It is anticipated that the ESMA fund rules will exclude a number of existing Article 8 and 9 funds due to the more stringent thresholds.
Analysis conducted earlier this year by data and research provider Morningstar Sustainalytics identified 4,300 EU-domiciled funds with ESG or sustainability-related terms in their names, noting that 44% of funds with ‘sustainable’ in their name would need to increase their sustainable investment allocations, adjust their methodologies or rebrand.
Although the fund names rules will likely introduce short-term volatility as fund managers comply with the requirements, they will ultimately ensure there is greater clarity surrounding the marketing of funds for both retail and institutional investors, said Premlata Fagan, Financial Regulation Managing Associate at law firm Linklaters.
“Given the lengthy timeframe required for changes to the Level 1 SFDR rules to take effect, [ESMA’s] stop-gap solution helps effect the drive for greater transparency for investors without unnecessary delay,” Fagan added.
Sea change
The initial review of SFDR – expected next year – is likely to be the first in a series of tweaks to the regulation, according to experts.
One area of future focus concerns SFDR’s principal adverse impacts (PAIs) – a set of metrics measuring how an entity’s investments affect sustainability factors.
Under SFDR, financial market participants are required to publish a PAI statement on their website regarding the impact of their activities on sustainability factors. Such disclosures should also feature in pre-contractual information.
Fund managers also have to disclose how PAIs are being considered within their products.
“It is not simply a matter of reporting the PAI, but rather about understanding what taking that impact into account entails,” said Finance Watch’s Vandeloise. “This can be very subjective – such as when applied to different sectors.”
Building on two previous PAI assessments by the European Supervisory Authorities, the latest iteration noted progress, although the share of fund managers disclosing remains low overall.
“There’s a general call from some players for PAIs to be disclosed at the product level,” Vandeloise said. “Sustainability-focused investors will select a fund based on its PAI, so it’s much more relevant to get that additional level of granularity to understand the fund.”
But entity-level PAI disclosures ensure service providers have to explain their due diligence and engagement processes to mitigate and remediate adverse impacts, Eurosif’s Garrault agreed.
“We believe they should be maintained in the SFDR and improved upon, also avoiding potential duplications with other pieces of regulation,” he said.
Increased alignment between SFDR and other pieces of regulation is also crucial.
Garrault highlighted discrepancies between SFDR and the EU Taxonomy, such as the former defining sustainable investments and the latter more specifically identifying environmentally sustainable investments. This makes it more challenging for fund managers to draw parallels between the two.
“Articulation between the two has always been difficult for investors, as EU taxonomy assessments are made at the economic activity level, whereas the SFDR assessment is made at the entity-level,” he said.
Garrault suggested one solution could be to extend the taxonomy to include intermediate and harmful activities so it can better serve as a tool for identifying the trajectories of financial products.
In the shorter term, there is also concern that ESMA’s incoming rules will create similar inconsistencies with other sustainable finance regulations, such as the EU Green Bond Standard.
Future unknown
Asset managers and the clients face ongoing uncertainty, with the timeline and direction of the first review still unknown.
In an introductory statement earlier this month, European Commissioner-designate for Financial Services and Savings and Investments Union confirmed that a more official and comprehensive labelling regime was needed.
ESMA is expected to publish further SFDR guidance and a Q&A document next year, and the EU Platform on Sustainable Finance (PSF) is also preparing a report outlining potential criteria that could be attached to new product categories under the regulation.
“Whatever form the ‘new’ SFDR takes, we can be confident it will expect greater transparency, ensuring decisions around an in-scope product’s naming, marketing, and constitution are appropriate, well-documented and justifiable will be key,” said Terry Yiangou, Financial Regulation Managing Associate at law firm Linklaters.
The post EU Names Rules a Stop-gap Solution to Greenwashing appeared first on ESG Investor.