Investment funds retaining ESG terms in their names have reduced their portfolio share of fossil fuel holdings more than other funds since the publication of ESMA ESG fund naming guidelines, according to the supervisor.
In a study on the impact of the guidelines, it said the difference was driven to some extent by net investor flows from funds retaining ESG words, while the decarbonisation trend could also be traced to before the publication of ESMA’s guidelines.
However, it also said the result “suggests that the intended signal sent to the EU fund community was effective, with increased efforts among funds retaining ESG terms in their names to green their portfolios and improve alignment with the signal conveyed by their names”.
ESMA’s fund naming rules came into force fully in May. The rules require funds that use language associated with six themes (transition, environment, social, governance, impact and sustainability) to invest at least 80% of their assets in accordance with the Sustainable Finance Disclosure Regulation (SFDR).
They must also adopt blanket environmental and social exclusions, which vary in ambition depending on the type of word used.
For its study published this week, ESMA drew on nearly 1,000 fund manager notifications in reaction to the guidelines from the 25 largest EU asset managers.
It found that 64% of the funds mentioned in the shareholder notifications changed their name, in most cases to avoid the use of ESG-related terminology. Meanwhile, 56% updated their investment policies to strengthen their sustainability focus, mainly by introducing fossil fuel-related exclusions.
The majority of name changes involved removing all ESG terms, with half of these funds adopting alternative terminology in their name.
Portfolio composition influences compliance choice
The supervisor also focused on the fossil fuel-related exclusion provisions in its guidelines to successfully test its theory, which is that the larger the share of non-compliant investments within a fund portfolio prior to the application of the ESMA Guidelines, the more likely it was that the fund manager would choose to change the fund name, as opposed to adjusting the investment policy.
It used funds’ portfolio exposure to companies involved in fossil fuel activities covered by Paris-Aligned Benchmark (PAB) exclusion provisions as a proxy for the “compliance gap”, and said that the results of its analysis showed that “fund managers were more likely to rebrand their funds when faced with higher divestment needs to comply with the rules”.
PAB exclusions were one of the main provisions in the fund naming guidelines against which the investment management industry tried to push back, ESMA noted.
Following a consultation on the then draft guidelines, ESMA conceded that blacklisting fossil fuels would stop some funds targeting companies central to the energy transition, so it tweaked the final rules to enable ‘transition’-labelled funds to use the criteria of a lighter version of the PAB’s screens, without energy exclusions.
Funds with environmental-, impact- or sustainability-related terms in the name have to apply the full restrictions under the PAB criteria.
Overall, ESMA said its study found that its guidelines had improved consistency in the use of ESG terms by increasing alignment of fund names and their actual investment strategies, and enhanced investor protection by reducing greenwashing risks.
As previously reported by IPE, plans to turn SFDR into a labelling regime could complicate life for investment funds, given the overlap with ESMA’s fund naming guidance. The European Commission published its proposals for an overhaul of the SFDR last month.
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