The European Security and Markets Authority (ESMA) has recently unveiled updates to its guidelines on ESG and sustainability-related terms in fund names, carrying over important implications for the FinTech sector specifically, especially areas which encompass sustainable and ethical investments.

What is the ESMA and its objectives?

The ESMA, acts as the European Union’s financial markets regulator and operates with three primary objectives to safeguard the interests of investors, ensure the orderly functioning of markets, and guarantee financial stability and resilience to withstand financial shocks [1]. Ensuring effective markets and financial stability is a core focus for the ESMA. The agency aims to promote fair and orderly financial market functioning with a more ethical stance of upholding high standards of conduct and transparency to support market efficiency and investor confidence.

The ESMA plays an important role in identifying and assessing market developments that pose threats to financial stability. By collaborating with other key divisions such as the European Systemic Risk Board (ESRB) and the European Banking Authority (EBA), the ESMA contributes to the development of an efficient and accessible EU Single Market in financial services.

In its commitment to global standards, the ESMA also participates in international opportunities such as the International Organization for Securities Commissions (IOSCO) and the Financial Stability Board (FSB). This close collaboration with the IOSCO and FSB ensures the integration of international markets with the openness and transparency of the EU single market.

Strengthening the supervision of EU financial markets is another key aspect of ESMA’s role. The agency works towards shared principles of supervision between the ESMA and the National Competent Authorities (NCAs), utilizing tools such as an EU-wide risk supervisory convergence heatmap, stress-testing, stakeholder outreach, and prioritized supervisory activities.

As the ESMA has also an important role to play in enhancing the protection of retail investors the ESMA strives to ensure that EU retail investors are effectively and equally protected, particularly from emerging risks related to new distribution channels and innovative products. Using modern communication tools and platforms, the ESMA can leverage its ability to get through more easily to retail investors to provide clear, reliable, and understandable product information. Moreover, by contributing to the development of the EU regulatory framework, ESMA aims to facilitate long-term direct and indirect retail participation in the EU capital markets. [2]

ESG Fund Guidelines Update

The latest announcements by the ESMA in its effort to continue its commitment as the EU’s regulator has shed light on the postponement of the ESG fund naming guideline adoption, a strategic move by ESMA to integrate the outcomes of reviews pertaining to the Alternative Investment Fund Managers Directive (AIFMD). Recently, the interinstitutional negotiations reached a temporary agreement, giving ESMA new responsibilities. One of these tasks is to create guidelines for cases where the names of investment funds are unclear, unfair, or misleading.

Anticipated for approval and publication in the second quarter of 2024, depending upon the decision by AIFMD, these guidelines will come into effect three months after being published on the ESMA’s website, available in all official EU languages. The importance of these updates is significant for fund managers, particularly those venturing into new fund launches, as compliance with the guidelines is mandatory from the date of application. Existing fund managers will be granted a six-month period from the application date to ensure their funds align with the new regulations. (Figure 1) [3]

What do the ESMA guidelines regulate?

The guidelines regulate fund designations involving ESG or sustainability terms. They will apply to both fund managers and national competent authorities. It is expected by the new guidelines that fund names and marketing must avoid misleading information and full transparency must be demonstrated to develop confidence with the retail investors.

The first regulation is the use of the word sustainable. If a fund is marketed using this terminology it should be the assignees responsibility to ensure 80% of that fund can be invested in ESG investments within the meaning of the SFDR, of which 50% should be allocated to sustainable investments. [4]

The second regulation to fall within the guidelines is the use of an ESG-related term in a fund’s name. At least 80% of the investments must align with disclosed environmental or social characteristics under SFDR delegated regulation. [4]

The third component of the guidelines covers minimum safeguards. Where a fund with an ESG or sustainability-related term in their name take or comply with minimum safeguards. This excludes areas such as weapons, tobacco that violate the principles of the United Nations Global Compact (UNGC) and Organization for Economic Co-operation and Development guidelines. Nonetheless, limited investments are permitted in specific raw materials. It is recommended that managers assess carefully and consider adherence to the ESMA’s recommendations. An alternative approach laid out by the ESMA involves creating a fund that focuses on “good governance,” potentially simplifying compliance. [5]

Fourth, a fund that designates an index as a benchmark may include ESG and sustainability-related terms in its name if the requirements of the first and second guidelines are met. The ESMA understands and expects that for the fund to designate an index as a benchmark it should of also met the criteria if the word “sustainable” or a word derived from it is also used.

Finally, for use of the word impact or impact investing, or any other impact-related term in their name, the fund must also comply with the requirements of the first and second guidelines and make sustainable investments with the intention of achieving positive environmental or social outcomes and the impacts from those investments for a financial return. [5]

With an approval set for Q2 of 2024, the ESMA’s forthcoming ESG fund naming guidelines, aim to enhance transparency and credibility in the investment sector. Immediate compliance will be required for new funds, with a six-month grace period for existing ones. It is expected these guidelines will also complement the SFDR with a positive impact for complying companies by instilling investor confidence through greater transparency and adherence to ESG principles involved in capital financial markets.

Sources

• https://european-union.europa.eu/institutions-law-budget/institutions-and-bodies/search-all-eu-institutions-and-bodies/european-securities-and-markets-authority-esma_en
• https://www.esma.europa.eu/about-esma
• https://fintech.global/2023/12/19/esma-sets-new-timeline-for-crucial-esg-fund-naming-guidelines/
• https://www.simmons-simmons.com/en/publications/claqpy8kc5y6p0a08fy37jgy3/esg-esma-consults-on-guidelines-for-esg-related-funds-names
• https://paytechlaw.com/en/esma-guidelines-funds-names-esg-sustainability/