Europe leads the way with new, strict guidelines for what can be labelled as sustainable investment funds.
On May 14th, 2024, The European Securities and Markets Authority (ESMA) published its final report with guidelines aiming to reduce greenwashing risks. The initiative introduces standards for fund managers that promote UCITS and alternate investment funds in Europe, using labels such as sustainable, impact, environmental, social, governance and transition to promote their funds.
New thresholds for proportion fo sustainable investments
The report followed a consultation period from November 2022 to February 2023, in which ESMA“ received significant input from stakeholders”, which is EU language to say that these guidelines have drawn a lot of attention from the investment community. The final guidelines now require a number of standards to be met, including an 80% minimum investment proportion to support the sustainability characteristics of funds using sustainability-related terms in its names.
During the consultation process, several amendments were made, including raising the threshold from 50% to 80%, to address stakeholder criticism that 50% was “too discretionary” for fund managers.
While ESMA recognizes that there is still not one single, robust standard for how to calculate or classify a sustainable investment, the new guidelines provide clear guidance on how big a proportion of a fund’s allocations that have to live up to the sustainability definition that the fund manager applies, in accordance with SFDR regulation art 2(17). In addition, a number of exclusion criteria need to be applied, depending on which term a manager chooses for their fund.
There is room left for interpretation
As we have previously highlighted in our research the ability for managers to set their own sustainable investment (SI) definitions creates a market that is hard for the end investor to navigate. For example, one manager may define a “substantial contribution” to be that a company needs to derive a minimum 20% of its revenue from products and services that address one or more UN SDGs, whereas others may be using less recognised frameworks and less transparent methods to operationalise them (think of ratings, for example). But as more companies report the data needed to evaluate their alignment with regulatory sustainability definitions like the EUTaxonomy, the optimists are hoping that SI definitions will become more unified in the future.
Notwithstanding the lack of alignment around methodological definitions, it is still a positive development that the threshold for sustainable investments in a fund carrying a sustainability-related label, has been set to 80% on an EU-wide basis. This also counters the lack of standardisation around these minimum requirements, that has until now been prevalent among EU countries, as they have applied different rules with different methods, which leads to a fragmented market.
But critics are also warning that a threshold at only 80% is not enough to guarantee investors that the products they choose are indeed sustainable. For example, a fund manager may pursue a strategy that is labelled as “sustainable”, but still include a few tech giants that do not contribute substantially to any globally acknowledged sustainable outcome.
Nuanced requirements enable different approaches
In addition to setting the SI-threshold at 80%, the new guidelines also introduce various screening criteria, depending on which label that the fund uses. In simplified terms, these criteria are largely the same as those required for Paris-Aligned (PAB) and Climate Transition benchmarks (CTB) and associated products. What this means in layman’s terms, is that EU is tightening the criteria for which industries and activities, that are deemed too controversial to fit into responsible and sustainability-labelled investment strategies. The exact exclusion criteria however vary, depending on which label a manager chooses to brand their fund.
For example, the new guidelines also introduce a “transition” category for investment strategies that target a greener economy. These strategies, that may use terms like“transition”, “progress,”, “improving” and “evolution”, also need to live up to an 80% threshold, but have less restrictive exclusion criteria, to enable investments into companies that are currently problematic, but on a course to transition.
The guidelines introduce more notable updates, but if you are starting to lose track of what all this means, we have provided a summary of some of the highlights in the bottom of this post.
Fund managers need better data
There is a chasm in sustainable investments, dividing managers into two camps: Those that want a more unified playing field with stronger definitions, and those that would prefer to define their own customer promises with full discretion – even when it comes to using terms like “sustainable investing”. Whichever side of this divide you find yourself on, all managers promoting products in Europe are unified by an increasing need for better data and reporting solutions, to back up the promises they are making on behalf of their investment strategies. Long gone are the days where a general ESG integration, using externally provided ratings, would be enough to slam a “clean” or “sustainable” label on a strategy. As the requirements to managers are shifting, so is their need to understand and report on their investment decisions.
At Matter, we have seen a significant increase in the need for more granular data solutions, that for example can help a portfolio manager fully understand and qualify what goes into their funds, and tie this – with full transparency and data lineage – to the definition of substantial contribution and do-no-significant harm, that they disclose to clients and regulators. In other words, the new rules demand new standards for ESG and sustainability data.
In response to the publication of the revised guidelines, Matter’s CEO Niels Fibæk-Jensen commented to Funds Europe, that “Investors needto be able to interact directly with the data, to be able to screen for specific things to be more accurate in their assessments of how an asset fits into a wider ESG investing strategy. This is why we are seeing a push from sophisticated investors towards a lot more granular data than traditional, broad rating and scoring solutions.”
If you want to better understand how the revised guidelines affect you, or are looking for guidance or data solutions to qualify your strategies, please reach out. We are happy to provide our view and connect you to our experts.
And as promised, here isa condensed version of some of the key highlights in the new guidance.
Recommendations to fund managers on the use of terms in funds’ names
All funds using transition-, social-, governance, environmental, sustainability or impact-related terms should meet an 80% threshold linked to the proportion of investments used to meet environmental or social characteristic or sustainable investment objectives in accordance with the binding elements of the investment strategy
Additionally,
You can find the final ESMA guidelines here
On May 14th, 2024, The European Securities and Markets Authority (ESMA) published its final report with guidelines aiming to reduce greenwashing risks. The initiative introduces standards for fund managers that promote UCITS and alternate investment funds in Europe, using labels such as sustainable, impact, environmental, social, governance and transition to promote their funds.
New thresholds for proportion fo sustainable investments
The report followed a consultation period from November 2022 to February 2023, in which ESMA“ received significant input from stakeholders”, which is EU language to say that these guidelines have drawn a lot of attention from the investment community. The final guidelines now require a number of standards to be met, including an 80% minimum investment proportion to support the sustainability characteristics of funds using sustainability-related terms in its names.
During the consultation process, several amendments were made, including raising the threshold from 50% to 80%, to address stakeholder criticism that 50% was “too discretionary” for fund managers.
While ESMA recognizes that there is still not one single, robust standard for how to calculate or classify a sustainable investment, the new guidelines provide clear guidance on how big a proportion of a fund’s allocations that have to live up to the sustainability definition that the fund manager applies, in accordance with SFDR regulation art 2(17). In addition, a number of exclusion criteria need to be applied, depending on which term a manager chooses for their fund.
There is room left for interpretation
As we have previously highlighted in our research the ability for managers to set their own sustainable investment (SI) definitions creates a market that is hard for the end investor to navigate. For example, one manager may define a “substantial contribution” to be that a company needs to derive a minimum 20% of its revenue from products and services that address one or more UN SDGs, whereas others may be using less recognised frameworks and less transparent methods to operationalise them (think of ratings, for example). But as more companies report the data needed to evaluate their alignment with regulatory sustainability definitions like the EUTaxonomy, the optimists are hoping that SI definitions will become more unified in the future.
Notwithstanding the lack of alignment around methodological definitions, it is still a positive development that the threshold for sustainable investments in a fund carrying a sustainability-related label, has been set to 80% on an EU-wide basis. This also counters the lack of standardisation around these minimum requirements, that has until now been prevalent among EU countries, as they have applied different rules with different methods, which leads to a fragmented market.
But critics are also warning that a threshold at only 80% is not enough to guarantee investors that the products they choose are indeed sustainable. For example, a fund manager may pursue a strategy that is labelled as “sustainable”, but still include a few tech giants that do not contribute substantially to any globally acknowledged sustainable outcome.
Nuanced requirements enable different approaches
In addition to setting the SI-threshold at 80%, the new guidelines also introduce various screening criteria, depending on which label that the fund uses. In simplified terms, these criteria are largely the same as those required for Paris-Aligned (PAB) and Climate Transition benchmarks (CTB) and associated products. What this means in layman’s terms, is that EU is tightening the criteria for which industries and activities, that are deemed too controversial to fit into responsible and sustainability-labelled investment strategies. The exact exclusion criteria however vary, depending on which label a manager chooses to brand their fund.
For example, the new guidelines also introduce a “transition” category for investment strategies that target a greener economy. These strategies, that may use terms like“transition”, “progress,”, “improving” and “evolution”, also need to live up to an 80% threshold, but have less restrictive exclusion criteria, to enable investments into companies that are currently problematic, but on a course to transition.
The guidelines introduce more notable updates, but if you are starting to lose track of what all this means, we have provided a summary of some of the highlights in the bottom of this post.
Fund managers need better data
There is a chasm in sustainable investments, dividing managers into two camps: Those that want a more unified playing field with stronger definitions, and those that would prefer to define their own customer promises with full discretion – even when it comes to using terms like “sustainable investing”. Whichever side of this divide you find yourself on, all managers promoting products in Europe are unified by an increasing need for better data and reporting solutions, to back up the promises they are making on behalf of their investment strategies. Long gone are the days where a general ESG integration, using externally provided ratings, would be enough to slam a “clean” or “sustainable” label on a strategy. As the requirements to managers are shifting, so is their need to understand and report on their investment decisions.
At Matter, we have seen a significant increase in the need for more granular data solutions, that for example can help a portfolio manager fully understand and qualify what goes into their funds, and tie this – with full transparency and data lineage – to the definition of substantial contribution and do-no-significant harm, that they disclose to clients and regulators. In other words, the new rules demand new standards for ESG and sustainability data.
In response to the publication of the revised guidelines, Matter’s CEO Niels Fibæk-Jensen commented to Funds Europe, that “Investors needto be able to interact directly with the data, to be able to screen for specific things to be more accurate in their assessments of how an asset fits into a wider ESG investing strategy. This is why we are seeing a push from sophisticated investors towards a lot more granular data than traditional, broad rating and scoring solutions.”
If you want to better understand how the revised guidelines affect you, or are looking for guidance or data solutions to qualify your strategies, please reach out. We are happy to provide our view and connect you to our experts.
And as promised, here isa condensed version of some of the key highlights in the new guidance.
Recommendations to fund managers on the use of terms in funds’ names
All funds using transition-, social-, governance, environmental, sustainability or impact-related terms should meet an 80% threshold linked to the proportion of investments used to meet environmental or social characteristic or sustainable investment objectives in accordance with the binding elements of the investment strategy
Additionally,
You can find the final ESMA guidelines here
