Key Takeaways:
- Fund names that include ESG or sustainability-related terms are subject to certain minimum requirements (such as a minimum percentage commitment to promote environmental and/or social characteristics or to make sustainable investments and applying an exclusions list).
- The new rules should apply to all funds being marketed in the European Union (the “EU”), three months after translations in all EU official languages have been published on ESMA’s website (the “Effective Date”).
- There is no grandfathering, and the Final Guidelines will also apply to funds that have held a final closing prior to the new rules becoming effective subject to an additional six-month transition-period from the Effective Date.
- The Final Guidelines are not mandatory and the national regulatory authorities in the EU can decide whether they will apply such guidelines going forward or not.
On 14 May 2024, the European Securities and Markets Authority (“ESMA”) published its
Final Report on the “
Guidelines on funds’ names using ESG or sustainability-related terms” (the “
Final Guidelines”). ESMA initially consulted on the topic in November 2022 (please find a link to our update
here) and subsequently provided an update in December 2023 (please find a link to our update
here). Consistent with the scope of the Sustainable Finance Disclosure Regulation (the “SFDR”), the Final Guidelines should apply not only to EU fund managers but also to non-EU fund managers marketing EU or non-EU funds in the European Economic Area.
The Final Guidelines apply to both retail and professional funds and broadly categorise terms used in fund names,
as: (i) transition-, social-, and governance-related terms; (ii) environmental- or impact-related terms; (iii) sustainability-related terms; and (iv) a combination of the above. Each category triggers certain minimum requirements for the fund’s investment strategy, as summarised below. Accordingly, the marketing materials and fund documentation will need to comply with the Final Guidelines.
The Final Guidelines will apply three months after the translations in all EU official languages have been published on ESMA’s website (the “Effective Date”) to fund managers of new funds (
i.e., funds created after the Effective Date). There are no grandfathering rules. Fund managers of funds existing before the Effective Date benefit from an additional transitional period of six months to comply with the Final Guidelines.
We summarise in this Debevoise Update the most important aspects for fund managers to consider as a result of the Final Guidelines.
Listed Terms in Fund Names and Related Restrictions. This table contains a non-exhaustive list of terms used in fund names and the corresponding restrictions that are triggered pursuant to the Final Guidelines.
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Restricted Fund Names
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Restriction
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“Environmental” terms in its name (e.g., “green”, “environmental”, “climate”, including “ESG” and “SRI”)
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- At least 80% of the fund’s investments must meet (a) the environmental and/or social characteristics promoted by the fund pursuant to Article 8 of the SFDR or (b)sustainable investment objectives of the fund pursuant to Article 9 of the SFDR.
- The fund must adhere to the full exclusion list prescribed under the EU Paris-Aligned Benchmarks (the “PAB”).
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“Sustainable” or sustainability-related terms in its name (e.g., “sustainable water”, “sustainable society”)
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- At least 80% of the fund’s investments must meet (a) the environmental and/or social characteristics promoted by the fund pursuant to Article 8 of the SFDR or (b)sustainable investment objectives of the fund pursuant to Article 9 of the SFDR.
- The fund must adhere to the full exclusion list prescribed under the PAB.
- The fund must commit to invest meaningfully in SFDR-aligned “sustainable investments”.
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“Impact”, or “impact investing” or impact-related terms in its name (e.g., “impacting” or “impactful”).
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- At least 80% of the fund’s investments must meet (a) the environmental and/or social characteristics promoted by the fund pursuant to Article 8 of the SFDR or (b)sustainable investment objectives of the fund pursuant to Article 9 of the SFDR.
- The fund must adhere to the full exclusion list prescribed under the PAB.
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Terms relating to “transition” in its name (e.g., “transitional” or words that derive from “improve”, “progress”, evolution, “transformation” and “net-zero”)
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- At least 80% of the fund’s investments must meet (a) the environmental and/or social characteristics promoted by the fund pursuant to Article 8 of the SFDR or (b)sustainable investment objectives of the fund pursuant to Article 9 of the SFDR.
- The fund must adhere to the exclusion list prescribed under the Climate Transition Benchmark (the “CTB”).
- ESMA recommends that a fund ensures that its investments are on a clear and measurable path to social or environmental transition.
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“Social” or “governance” terms in its name (e.g., “equality” or “controversies”)
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- At least 80% of the fund’s investments must meet (a) the environmental and/or social characteristics promoted by the fund pursuant to Article 8 of the SFDR, or (b)sustainable investment objectives of the fund pursuant to Article 9 of the SFDR.
- The fund must adhere to the exclusion list prescribed under the CTB.
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Use of Combined Terms. ESMA generally envisages cumulative treatment for funds that use a combination of ESG or sustainability-related terms in their names. For example, this would mean that, a fund combining an environmental- and a social-related term must meet the prescribed 80% asset allocation threshold and also ensure that its investments adhere to the PAB exclusion list.
However, to the extent a fund uses ESG- or sustainability-related terms in combination with “transition-related” terms, the fund will only have to fulfil the minimum requirements for transition-related terms as set out above (and, in particular, only comply with the limited exclusion list under the CTB).
Compliance, Reporting and Supervision. The Final Guidelines are addressed to National Competent Authorities (“NCAs”) and financial market participants which “must make every effort to comply with these”. However, NCAs must notify ESMA within two months following the Effective Date, of whether or not they intend to comply with the Final Guidelines, on an “explain-or-comply” basis. It remains to be seen if NCAs will opt to comply with the Final Guidelines. Therefore, the Final Guidelines use the term “should” when describing the requirements to be met when using ESG- or sustainability-related terms in fund names.
A temporary deviation from the 80% threshold or the applicable exclusion requirement will be considered a passive breach (which may be corrected in the best interests of the investors), so long as such deviation is not intentional. NCAs can investigate and initiate supervisory dialogue if a fund manager fails to comply, or does not “sufficiently” meet the minimum requirements, or fails to act honestly and/or fairly while using the restricted fund names. It will be interesting to see how NCAs handle these requirements for private equity funds that naturally have ramp-up periods before they reach the targeted asset allocation disclosed in their SFDR pre-contractual disclosure. If handled too strictly, a disadvantage for private equity funds (and similar asset classes such as private debt) may be the consequence.
Transitional Provisions and Industry Concerns. New funds established after the Effective Date must consider the Final Guidelines from day one. Funds established before the Effective Date will have an additional six months from the Effective Date to comply with the Final Guidelines (the “Transitional Period”). ESMA states it is “conscious of the efforts in terms of time that existing investment funds may have to go through in order to adapt to the guidelines” but is also of the view the transitions rules are “already very generous as the guidelines will start applying 3 months after the publication of the translation and with a further 6-month transitional period for existing funds it will give managers of existing funds a minimum of 9 months’ time to comply, without taking into account the time necessary for the translations”.
ESMA’s clarification in the Final Report indicates that ESMA makes no distinction between funds in fundraising and funds no longer in fundraising. Even closed-ended funds that were established before the Effective Date and are no longer being offered must adhere to the Final Guidelines after the Transitional Period. Therefore, fund managers should assess whether it is more feasible to change the name of the fund or adjust the investment strategy to retain the name.
Next Steps. Managers of funds containing ESG or sustainability-related terms in their names ¾ including closed-ended funds ¾ should start analysing possible implications of the Final Guidelines on their fund strategies and disclosures. This may entail, either (i) changing the name of the fund to bring it outside the scope of the Final Guidelines or (ii) adjusting a fund’s investment strategy to comply with the Final Guidelines, both of which may require changes to the fund’s legal documents, which, in turn, may potentially be subject to certain investor notification or consent rights. Given the fact that professional investors have once been admitted to such a fund while knowing of both the investment strategy and the fund name, these options seem disproportionate and are a disadvantage for private equity funds and similar funds (e.g., private debt funds or infrastructure funds).
This publication is for general information purposes only. It is not intended to provide, nor is it to be used as, a substitute for legal advice. In some jurisdictions it may be considered attorney advertising.