Blurred Lines Will Weaken ESMA Labels – EFAMA

Proposed sustainable investment thresholds risk divergence from SFDR. 

Market participants have called for a delay to the European Securities and Markets Authority’s (ESMA) draft rules for sustainability and ESG fund labels until there is more clarity on terminology and interoperability with existing disclosure standards.  

To combat greenwashing, ESMA’s consultation, which closed last week, proposed new investment thresholds that EU-domiciled funds will have to reach to qualify for a ‘sustainable’ or ‘ESG’ label, a move which will impact around 14% of the EU’s 29,000 investment fund universe.  

However, central to ongoing debate is ESMA’s decision to align with the Sustainable Finance Disclosure Regulation’s (SFDR) definition of ‘sustainable investment’, which encompasses any investment in an economic activity that contributes to an environmental or social objective. Industry says this implies that a ‘sustainable investment’ can only be calculated at the activity level, which leaves the definition open to interpretation and potential greenwashing.  

“We don’t think it’s appropriate to introduce fund-labelling rules based on a concept already exposed to such varied interpretations and controversy within the market,” Anyve Arakelijan, Regulatory Policy Advisor at the European Fund and Asset Management Association (EFAMA), told ESG Investor. 

In its consultation response, EFAMA has called for ESMA to delay the implementation of its fund-labelling rules until the European Commission has responded to the European Supervisory Authorities’ (ESAs) previous request for clarity around the SFDR definition of ‘sustainable investment’. 

“It’s a sequencing issue,” added Andreas Stepnitzka, EFAMA’s Deputy Director of Regulatory Policy. “It’s very hard for [investors] to know the right way to structure their products when there is still this lack of clarity. Once investors fully understand those concepts and terminologies, it will be easier for them to comply [with ESMA’s requirements].” 

There are additional planned reforms for SFDR expected in the coming months which “may consider binding requirements for product design and fund naming”, the EFAMA consultation response noted, including introducing minimum criteria for Article 8 (environmental and/or social characteristics) funds and the adoption of ESAs’ proposed amendments to the SFDR Regulatory Technical Standards (RTS). 

National and global interoperability 

ESMA’s suggested thresholds for its labels risk divergence from SFDR rather than alignment, EFAMA warned. 

The draft guidance will require EU-domiciled funds with an ESG-related label to meet an 80% sustainable investment threshold, whereas any funds with a sustainability-related label will additionally be expected to ensure that 50% of that 80% threshold qualifies as sustainable investments under SFDR.  

“A situation must be avoided where a fund meets the SFDR Article 8 and 9 (environmental and/or social objectives) criteria but cannot use ‘ESG’ and/or ‘sustainable’ in its name, as the ESMA thresholds are not met,” noted the EFAMA response.  

There is the possibility this could prompt another wave of re-labelling by asset managers, as was seen with Article 9 to 8 downgrades in anticipation of SFDR Level 2 late last year, both Arakelijan and Stepnitzka said.  

ESMA need to take a more “proportionate look” at how fund-labelling rules can fit in with existing regulation, Arakelijan said, noting that the guidance should align with SFDR’s focus on the investment processes, rather than outcomes and holdings.  

EFAMA has further proposed adjusting the 80% threshold to 70%, arguing that fund managers “need certain flexibility” to apply for cash or cash equivalents, as well as sovereign debt and derivatives.  

Interoperability with other emerging fund-labelling rules is also important, the EFAMA response said, such as the UK Sustainability Disclosure Requirements (SDRs) and the US Securities and Exchange Commission’s proposed updates to its ‘Fund Names’ rule.  

“Ultimately, we are supportive of an enabling framework that works well within the existing landscape and allows us sufficient time after the rules become applicable to adapt,” said Arakelijan.  

ESMA will now review all feedback and plans to finalise the guidance over the coming months. 

Separately, the ESAs are currently reviewing responses to their Call for Evidence on greenwashing. The findings will be outlined in the ESAs’ progress reports in May, with final reports due in May 2024. 

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