What does the latest European sustainability regulation mean for investors?
Our experts delve into the latest European sustainability regulation and the key implications for investors, as well as looking ahead to what’s in store in the next European parliament.
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The latest significant milestone in European sustainable finance regulation was the publication of the European Securities and Markets Authority’s (ESMA) guidelines on ESG fund names on 14 May. The aim of the guidelines is to ensure investors are protected against unsubstantiated or exaggerated claims in fund names, and to give asset managers clear criteria so they can assess which sustainability-related terms are appropriate to use in fund names.
Our experts explore the details within the fund name guidelines. They also examine some of the trends regarding ESG fund labels in Europe. And, after the European parliamentary elections that took place place on 6-9 June, they look at what’s been achieved in this mandate period and what’s to come.
What’s in a name?
Nathaële Rebondy, Head of Sustainability Europe: The ESMA fund name guidelines, summarised in the table below, carry several important implications. A key point is that all funds with sustainability/impact/ESG etc related terms in their names must ensure that at least 80% of their investments meet sustainability characteristics or objectives. This is aligned with the general fund names policy in the US and goes beyond the specific sustainability regime in the UK which requires 70%. This 80% threshold could, for example, pose a potential problem for private markets funds, which tend to hold higher cash buffers in their ramp-up and divestment phases.
Another important point is that funds with “sustainable” (or words related to sustainable) in the name must invest “meaningfully” in sustainable investments. As the guidelines do not define “meaningfully”, this is open to interpretation. Such funds must also be aligned with Paris Agreement benchmark (PAB) exclusions. These notably include coal, oil and gas as well as electricity production from fossil fuels, with different thresholds.
However, this “invest meaningfully” requirement does not apply to funds with “impact” in their name. Instead, such funds must be aligned with PAB exclusions and their investments must be made with the objective of generating positive, measurable social or environmental impact alongside a financial return.
Similarly, where a fund name combines any ESG or impact terms with “transition” then the “invest meaningfully” requirement does not apply. Instead, these funds must apply climate transition benchmark exclusions and ensure that investments are on a clear and measurable path to transition.
Indeed, the term “transition” is used in a very specific way in the guidelines. Because these funds are required to have investments with a clear and measurable path to transition, we understand that such funds cannot be solutions-oriented, i.e. investing in companies/securities that enable the transition, but the investments themselves must be transitioning.
We should highlight too that there are numerous other words that will trigger the requirements; for example, words like “improve” or “transformation” will trigger the same requirements as for “transition”. Somewhat surprisingly, “net zero” comes into the transition category rather than the environmental category.
And lastly, it’s important to understand that the guidelines apply to both active and passive funds, independently of the index benchmark, and that they also apply to closed-ended funds, even though these are no longer open to new investors.
When do the new guidelines take effect?
Elisabeth Ottawa, Head of Public Policy Europe: The guidelines need to be translated into all EU official languages and will take effect three months after this is done. We therefore expect them to enter into application in Q3 or Q4 2024 for new funds. Existing funds will have a transition period of additional six months, therefore they will apply to them in Q1 or Q2 2025.
The asset management industry will now digest the guidelines and we don’t exclude additional ESMA work on Q&As in the coming months as firms seek further clarity.
What’s coming up in EU sustainable regulation?
Elisabeth Ottawa: The EU parliamentary elections took place from 6 to 9 June. The results from certain countries have sprung some surprises. Overall though, the big pro-European parties (EPP - conservatives, S&D - social democrats, and Renew - liberals) are still holding a strong majority in the European Parliament. A number of MEPs who are key to ongoing European sustainable finance regulation will remain in place. This means we can expect continuity on the sustainability agenda.
Looking back, the EU has met the objective set in 2018 to include every element of the investment chain in sustainable regulation. Nevertheless, there are still some important updates to come in the next couple of months. We expect the publication this month of Frequently Asked Questions on the Corporate Sustainable Reporting Directive (CSRD). A report from ESMA on greenwashing has just been published. This is not a legislative report but will certainly also inform the European Commission’s considerations on a future SFDR (Sustainable Finance Disclosure Regulation).
Looking further ahead, in September we expect to see the adoption of the revised SFDR RTS (regulatory technical standards). This has been delayed given the elections, which means its entry into application is unlikely until the second half of 2025.
At the earliest at the start of next year, we’re expecting an SFDR 2 proposal, as well as technical details on the EU Green Bonds regulation, and more on sustainable reporting standards for small and medium-sized enterprises.
And a work in progress throughout the next years is the development of the new taxonomy criteria which continue to be refined.
Changes to European country sustainability labels
Nathaële Rebondy: European country labels continue to be important for fund distributors. This year there have been updates to guidelines around country labels, notably the French “Label ISR”, the Belgian label “Towards Sustainability” and the Austrian “Umweltzeichen” label. Some of these labels have been in place for many years.
The latest updates mainly relate to strengthening requirements around fossil fuels and exclusions. There are also more precise requirements related to active ownership, specifically engagement and voting. But, of course, not all the labels have made the same changes.
This will lead to a thorough review by asset managers of their funds with these labels. They will need to consider if it still makes sense to retain the label(s) from a commercial point of view. For example, European funds are sold in other jurisdictions such as Asia where client demand may differ.
Products need the right labels for the right markets. This needs to be based on clients’ interest and assets. If a significant change to investment strategy is needed in order to keep a specific label in one individual market, then that might not be the right outcome for fundholders in other parts of the world.
We therefore anticipate that the number of funds carrying these labels may drop in the near term, although there could be a pick-up again in future if new funds are launched that meet the labelling requirements from the outset.
There is a lot of fragmentation in the labelling regimes and we still hope for a label that could work across all of Europe to improve consistency.
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