The German fund industry association, BVI, has severely criticised the main elements of the draft guidelines on ESG and sustainability labels for investment funds proposed by the European Securities and Markets Authority (ESMA), asking the authority to defer from adopting the framework if the European Commission will consult on the review of the Sustainable Finance Disclosure Regulation (SFDR) this year.

ESMA is proposing a quantitative threshold (80%) for the use of ESG related words for funds, including a 50% threshold for the use of “sustainable” or any sustainability-related term.

It is also proposing the application of minimum safeguards to all investments for funds using such terms (exclusion criteria), and additional considerations for specific types of funds (index and impact funds).

In its response to ESMA’s draft guidelines, BVI is asking the authority to lower the 80% threshold because it limits the possibility of holding tools for liquidity management and hedging purposes in portfolios, ultimately impacting risk management.

Cash, money market instruments, index futures and other derivatives used for hedging purposes are either not aligned, or are difficult to assess in terms of ESG investment criteria in the absence of market standards, it added.

The association is also opposing the introduction of a 50% threshold for the use of the term “sustainable” or any sustainability-related term, as clarity is lacking on the criteria for sustainable investing.

A 50% threshold, based on the share of revenues generated by sustainable business activities, would be “far too high” for most investment strategies, it said, adding that it makes sense to link discussions on minimum quantitative requirements to the broader SFDR review.

The fund industry association is also warning of overlaps and potentially conflicting rules between the guidelines proposed by ESMA and the SFDR itself.

Keeping a share of sustainable investments in a portfolio “at all times”, as ESMA requires to receive the label, should be balanced by the possibility of diverging away from the commitment according to the investment strategy, as specified in the SFDR annexes, it said.

This balance is particularly relevant for funds investing in private equity, real assets and other less liquid markets, it added.

BVI is also opposed to the introduction of minimum safeguards for funds using ESG-related terms in its name, the introduction of Paris Aligned Benchmark (PAB) for exclusion that hinder investment strategies supporting the transition to sustainable business models, and thresholds for derivatives or any other assets already covered by the SFDR.

Impact investing means that funds deploy capital in polluting companies, but that are transitioning to sustainable business models.

BVI is instead proposing a debate on the distinction between transition-focused and other ESG investment strategies in the upcoming review of the SFDR.

For index-replicating funds, the association said they should follow the same rules as actively managed funds to receive the ESG label, but the issue of mandatory exclusions remains.

BVI’s chief executive officer, Thomas Richter, said that ESMA’s initiative to draft guidelines is positive as it draws a line to the patchwork of administrative practices across the EU with regard to requirements for funds, but the timing is bad.

“The European Commission is apparently planning a review of the [SFDR] in the summer and intends to discuss the introduction of ESG labels for all financial products. It would therefore be counterproductive to define ESG categories in advance exclusively for funds,” he said.

EFAMA questions threshold approach

Similarly, in its own response to ESMA’s consultation, the European Fund and Asset Management Association (EFAMA) also has concerns around the proposed numerical threshold approach as it may not address the underlying greenwashing issues the investment industry is facing due to the current lack of clarity on many key sustainable finance concepts.

EFAMA is in favour of setting common rules in order to avoid misleading information and to enhance trust and clarity in the market, especially in the fast-evolving ESG landscape.

“However, we suggest that ESMA delays their proposed guidelines until the lack of clarity on what constitutes a ‘sustainable investment’ is rectified and they have worked together with the European Commission to resolve interoperability issues between the guidelines and SFDR, MiFID/IDD etc,” EFAMA stated.

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.”

She continued: “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.”

If ESMA proceeds with the numerical threshold approach, there are a number of important elements that would still need to be addressed, EFAMA said, such as:

cash, cash equivalents, and derivatives used for hedging should be excluded from an 80% ratio calculation to allow for efficient fund management, especially during extraordinary market circumstances;

the lack of clarity on what exactly qualifies as a sustainable investment under SFDR, calls into question the appropriateness of a separate threshold of 50%.

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