Proposed rules on the use of ESG or sustainability-related terms in the names of investment funds unveiled by EU markets regulator the European Securities and Markets Authority (ESMA) will not fulfil their primary objective of protecting investors from greenwashing risk, according to Europe’s central investment industry trade association, the European Fund and Asset Management Association (EFAMA).

ESMA unveiled the proposed rules in November 2022, aimed at providing asset managers with clear criteria for the use of ESG or sustainability-related terms for funds, in order to ensure that investors aren’t misled about the investment products’ ESG characteristics.

Proposals included in the consultation primarily focused on the minimum proportion of investments required to support an ESG-related fund name. Specific proposals included an 80% threshold for the use of ESG-related words, an additional 50% threshold for the use of “sustainable” or any sustainability-related term, as well as rules for funds using exclusion criteria and for specific types of funds such as impact funds.

In its response to ESMA’s consultation on the new rules, however, EFAMA raised several concerns regarding the regulator’s proposed threshold approach, including interoperability issued with other regulatory systems such as MiFID or the EU’s Sustainable Finance Disclosure Regulation (SFDR), and a lack of clarity on many key sustainable finance concepts, such as “what exactly qualifies as a sustainable investment.”

EFAMA’s response also suggested that the use of different for the use of terms “ESG” and “sustainable” may cause confusion for retail investors, who typically can’t make distinctions between the terms.

While supporting efforts to promote transparency and tackle greenwashing risk, in its response commentary, EFAMA said that ESMA’s proposed criteria goes beyond SFDR’s requirements, and argued that “if additional rules and criteria are indeed needed, it should be up to the co-legislators’ discretion and not be part of ESMA Guidelines.”

If the regulator decides to proceed, EFAMA suggested that ESMA should either delay the guidelines until the clarity and interoperability issues are addressed, or revise the proposals.

In a statement released alongside the EFAMA response, Anyve Arakelijan, Regulatory Policy Adviser at EFAMA, said:

“It is unlikely that a methodology built on an unclear legal definition will increase investor understanding of ESG funds and adequately address greenwashing concerns. Rather than imposing a threshold, it would be more proportionate to mirror ESMA’s supervisory guidance on sustainability risks and disclosures by ensuring that use of ESG-related terms is supported in a material way with sufficient evidence of sustainability characteristics in the fund’s investment objectives and strategy.”

Click here to access EFAMA’s response to the ESMA consultation.

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