ESMA Under Pressure on ESG Fund Labelling Rules

European financial regulator faces up to criticisms of its plans for ESG label rules, with concerns focusing on the EU’s Sustainable Finance Disclosure Regulation (SFDR).

The European Securities and Markets Authority (ESMA) faced a two hour-long grilling this week on its plans to introduce labelling rules for funds using ESG, sustainable or impact in their name; with critics warning of the confusion this could add to the market.

The impact of the new rule is not insignificant given that around 14% of the EU’s investment fund universe of 29,000 funds will be affected, as estimated by ESMA. 

And significantly, market participants warn EU’s beleaguered Sustainable Finance Disclosure Regulation (SFDR) could overlap, and potentially conflict with, ESMA’s plans for labelling rules.

SFDR, broadly, is a disclosure requirement for funds relating to their sustainable investments, involving three categories Article 6 (do not integrate any sustainability), Article 8 (environmental and/or social characteristics) and Article 9 (environmental and/or social objectives) funds.  

However, it has had a mixed reception by the investment fund market, with managers being forced to downgrade funds from Article 9 to Article 8 in anticipation of updates to the rules announced this month. So-called SFDR Level 2, which brings in further disclosure requirements, has done little to alleviate confusion.

ESMA officials took questions, during an online hearing, from market participants who raised a number of issues, including how its plans related with SFDR.

Verena Ross, Chair at ESMA, said its labelling plans were necessary to address greenwashing risks in the bloc, with its main concern being funds that disclosed under Article 8.

At present, any fund could disclose under Article 8 without commiting to a minimum proportion of investment used to promote its environmental or social characteristics, she said. “Obviously that’s the extreme. We don’t expect that for most people,” she noted. But she added it was possible that some funds did not include a certain proportion of their investments living up to the commitments that the name of their fund implied.

ESMA draft guidance, under consultation until 23 February, states that any EU-domiciled fund with an ESG-related label must meet an 80% sustainable investment threshold. Additionally, any funds with a sustainability-related label are additionally expected to ensure that 50% of that 80% threshold qualify as sustainable investments under SFDR.

ESMA is also, separately, calling for evidence on greenwashing. It is currently reviewing submissions on this.

Derville Rowland, Chair of ESMA’s Investment Management Committee and Director General of the Central Bank of Ireland, also implied that its actions were needed, in addition to SFDR disclosure requirements, to combat greenwashing.

“It has been our lived experience as regulators that a number of investment funds have not been fully aligned when it comes to the characteristics of their underlying investments and how these funds have been marketed, betraying investors,” Rowland said.  

ESMA policy officials also reiterated at numerous points throughout the hearing that its proposed rules for labelling funds were very separate from SFDR, although it drew upon SFDR’s definition of a sustainable investment – which has also confused the financial market. ESMA said it would be open to other ways to define a sustainable investment, such as those included in MiFID II.

Other concerns were that ESMA should wait for a potential revision to SFDR before acting, but it was noted this would take many years to happen, when greenwashing was happening now.

“Obviously, we are considering the bigger picture as well. I hope that you don’t have the impression that we are acting in a silo over here,” said an ESMA official, who added the regulator would make sure it was also adaptable to changes with the proposed rules. 

Minimum safeguards will also apply to funds, under ESMA’s proposed rules, using exclusion criteria. ESMA will undertake additional considerations for index and impact funds.  

ESMA also said during the hearing that it chose to be aligned to exclusions made under the EU Paris-aligned benchmark rather than Climate-transition aligned benchmarks to make sure coal wasn’t included in any funds with ESG or sustainable in their name – but it was consulting on whether there needed to be a separate consideration for funds which were related to the climate transition. 

Other considerations discussed by ESMA were on whether specific criteria is needed for fund structures such as fund of funds or transition funds and whether it will be appropriate to extend the guidelines beyond investment funds to all financial products.


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