EU markets regulator the European Securities and Markets Authority (ESMA) announced today the release of its finalized guidelines for the use of ESG and sustainability-related terms in investment fund names, including investment thresholds required for sustainable investment funds, and the establishment of a transition category for investments that are not yet green, but are on a positive trajectory towards achieving environmental sustainability goals.

According to ESMA, the new guidelines were established as investor demand for ESG-focused funds has increased sharply, creating incentives for asset managers to include sustainability-related terms in fund names to attract investors, leading to an increased risk of greenwashing. In a recent study released by ESMA, the regulator found that there has been a sharp increase in the use of sustainability-related terms in fund names in Europe over the past several years, with the proportion of funds using ESG terms up more than 4x in 10 years, as fund managers launched new ESG-related products, and changed the names of funds to incorporate sustainability-related terms. The study also found a preference by fund providers for more generic ESG terms, which could make it difficult for investors to verify that investments align with the funds’ names.

ESMA’s finalized guidelines follow the launch by the regulator of a consultation on proposed guidance in November 2022. In the initial proposal, ESMA introduced a threshold of the minimum proportion of investments required to support an ESG-related fund name, including an 80% threshold for the use of ESG-related words, and a 50% threshold for the use of “sustainable” or any sustainability-related term. It also recommended exclusion criteria for such funds based on the EU’s rules for Paris Aligned Benchmarks (PABs), which fossil fuel companies and electricity producers with high GHG emissions.

The inclusion of different thresholds for ESG and for sustainability-related terms was met by criticism from investor groups, who suggested that the system may cause confusion for investors who often do not distinguish between the terms. The feedback also reflected demand for transition-related terms to promote investment strategies aimed at fostering a path to a greener economy.

In the finalized guidelines, ESMA removed the 50% sustainability-related threshold, while retaining a requirement for an 80% minimum proportion of investments used to meet the sustainability characteristics of funds using the term “sustainable,” and introducing a commitment to meaningfully invest in sustainable investments.

ESMA’s final guidelines also include a transition category, which includes terms such as “improving,” “progress,” “evolution,” and “transformation.” The transition category also includes an 80% investment threshold, while applying exclusions from the EU’s rules for Climate Transition Benchmarks (CTBs), instead of PABs, in order to enable investment in companies deriving part of their revenues from fossil fuels.

The new guidelines will begin applying three months after publication in all EUB languages on the ESMA website.

Click here to access the new guidelines.