The ESMA Guidelines on funds’ names: A persistent greenwashing risk for sustainable funds?
The below article was originally written by Diego Liendo Ganoza (Corporate & Financial Law LLM student) as part of his ‘Law and Sustainable Finance’ coursework, and is republished here with his permission.
Greenwashing, defined as the practice of making misleading sustainability claims about financial products to attract investors, remains a pressing concern in the EU’s sustainable market (ESMA, 2024d para.1, 19). As investors increasingly seek sustainable opportunities, expectations have risen for supervisors, like the European Securities and Markets Authority (“ESMA”), to step in and ensure investor protection and market integrity (ESMA, 2024d para.1).
In that context, asset managers in the EU have been facing increasing scrutiny over the naming and sustainable practices of the funds under their administration (Newlands, 2024). This challenge arises in light of the introduction of the ESMA Guidelines on funds’ names using ESG or Sustainability-related terms (the “Guidelines”), which took effect on November 21, 2024, for new funds, while for pre-existing funds would apply on May 22, 2025 (ESMA, 2024a, para. 26).[1]
Designed to address the green market pressures that incentivize asset managers to incorporate such terms in fund names, the Guidelines aim to mitigate the risk of misleading sustainability claims by establishing specific requirements for their use (ESMA, 2024a, para. 3).
This article shares some ideas about such requirements and assesses their adequacy in addressing greenwashing risks in the EU market, particularly in the case of sustainability-linked named funds.
The Guidelines and Greenwashing risks
To enhance investor protection, the objective of the Guidelines is to ensure that funds’ names are clear, fair, and non-misleading by establishing conditions for using sustainability or ESG-related words in fund names (ESMA, 2024a, pp.4-5). This focus is critical, as fund names strongly influence investors' decisions (as a big first impression) and are frequently used by asset managers as a key marketing strategy (ESMA, 2024b, para.6).
In that regard, the naming or misnaming of funds potentially represents a significant greenwashing risk in the market. Greenwashing, specifically, occurs when sustainability-related statements, declarations, or communications do not accurately embody the underlying sustainability profile of a financial product (e.g., funds) (ESMA, 2024d, para. 231). This not only creates confusion in the market but also undermines the investors’ trust and their protection.
As an example of such greenwashing prevalence, ESMA identified 630 greenwashing-related incidents or controversies involving misleading communications of companies listed on the STOXX Europe 600 index (ESMA, 2023b, pp.6).
The urgency of addressing greenwashing becomes clearer when considering the extensive use of sustainability-related words. As of May 2024, 6,490 funds were named with ESG and/or Sustainable-linked terms, representing 9.6% of the total UCITS and AIF funds in the EU market (ESMA, 2024a, pp.46).
With the growing demand for these types of funds, ensuring the integrity of the sustainable market is crucial, making the effectiveness of the Guidelines a significant matter.
The Guidelines’ requirements for Sustainable-linked words for funds’ names
The following sections will evaluate ESMA’s specific requirements for using Sustainable-linked terms in fund names, focusing on their potential impact on improving transparency and reducing greenwashing. This review aims to determine the adequacy of these measures and how they interact with the regulatory framework, particularly the Sustainable Finance Disclosure Regulation (“SFDR”), a transparency tool that differentiates product types in the market considering sustainability risks and impacts.
a. At least 80% of the fund’s investments must promote environmental or social characteristics, or contribute to environmental or social objectives (ESMA, 2024b, para.18)
This threshold aligns with the SFDR Regulation dual-division between promoting environmental or social characteristics products, and contributing environmental or social objectives products (EP, Regulation 2019/2088, art.8-9). There is no surprise with such alignment. Since it entered into force, SFDR has become a de facto labeling system in the EU market (Ramos et al, 2024, pp.33).
However, such usage brought unintended consequences. SFDR’s high-technical approach, intended for discerning investors, was never designed as a marketing tool (Ramos et al, 2024, pp.33-34). This problem becomes evident when comparing the criteria for articles 8° (“Light Green”) and 9° (“Dark Green”) financial products:
Light Green
Promotes environmental and/or social characteristics, provided the investment follows good governance practices (EP, Regulation 2019/2088, art.8).
Dark Green
“Has sustainable investment as its objective”, meaning Investments in an economic activity that:
i) contributes to an environmental or social objective,
ii) does not significantly harm any of those objectives, and
iii) the investee companies follow good governance practices (in conjunction, “Sustainable Investments”) (EP, Regulation 2019/2088, art.2(17), 9).
As you may appreciate, unlike Dark Green funds, Light Green ones are not directly linked to the definition of Sustainable Investment. This could create absurd scenarios where a Light Green fund uses a sustainability-linked name while following less strict criteria.
For instance, a sustainability-linked-named fund might invest in a company with marginally better anti-air-polluting practices than its peers (screening and best-in-class/universe strategies), while still engaging in other activities that significantly harm other environmental objectives, such as water and marine protection (Regulation EU 2020/852, art.10). Even the European Commission has recognized that Light Green products could use overly broad strategies that lack true sustainability-related materiality (EC, 2021, pp.2).
In fact, according to Morningstar’s April 2024 report, 35% of Light Green funds (by assets) have a 0% target for sustainable investments, nearly 15% aim for a 0-10% range, and around 20% target 10-20% (Morningstar cited by Ramos et al, 2024, pp.33-34).
In that sense, by introducing the reference to environmental and social characteristics of Light Green funds into the 80% requirement, the Guidelines have transferred Light Green's elusive neutrality into sustainable-linked fund naming, thus replicating previous greenwashing risks.
As seen below, the Guidelines have forwarded additional restrictions to respond to this problem. However, we will note that such, considered as a whole, may not be sufficiently effective.
b. Investments in companies should exclude the listed under the EU Paris-aligned Benchmarks exclusion list (ESMA, 2024b, para.18)
ESMA determined that sustainability-linked-named funds should follow the exclusion criteria of the EU Paris-aligned Benchmark of investment on specific companies. Such exclusion list consists of, most importantly, companies with more than 1% of revenues from hard coal, and with more than 10% from oil exploration, extraction, or refining (EC, 2020, art.12).
Although most of the respondents to the Guidelines consultation indicated that such exclusion criteria provide further obligations than the ones established for Light Green Funds (ESMA, 2024a, pp.15), we agree with ESMA when they highlight this inclusion as the most important one to alleviate greenwashing risks, considering it rules-out in an objective way investments related to carbon-fossil (ESMA, 2024a, pp.16).
Accordingly, such an approach provides certainty for investors’ preference over non-carbon-fossil companies. This is especially reasonable if we consider the specific inclusion of transition-linked terms for fund names, which determines a different treatment for climate transition companies (e.g., carbon-fossil companies) (ESMA, 2024b, para.16).
Nevertheless, the exclusion does not account companies that may significantly harm specific environmental objectives, such as farming companies with heavy water use (e.g., soy and beef industries). Such non-consideration may still misdirect investors who rely on the sustainability of funds using sustainability-related terms.
c. Commit to invest meaningfully in Sustainable Investments (ESMA, 2024b, para.18)
The response to previous concerns about safeguarding true sustainability in the Guidelines may potentially be found in this third and last requirement. Initially, ESMA’s Consultation Paper for the Guidelines proposed that funds using sustainability-linked terms in their names shall allocate at least 50% of their investments to Sustainable Investments (ESMA, 2022, para 15). This meant it would have required compliance with stricter Dark Green product criteria on a higher level, allowing for better alignment with the appetite of sustainability-focus investors.
However, respondents to the public consultation questioned the practicality of the proposed threshold, arguing that it would exacerbate confusion in an already complex regulatory framework. They highlighted the lack of clear definitions (such as the inconsistent use of the term sustainable across regulations and the distinction between ESG-related and sustainability-related terms), as well as the overly discretionary and varied methodologies asset managers use to determine the percentage of the investments of a fund that are Sustainable Investments[2] (ESMA 2024a, pp.12, 36).
Moreover, it was pointed out that less than 20% of all EU Light Green Funds met the 50% target for Sustainable Investments, making the threshold unattainable for most funds (ESMA 2024a, pp.36).
ESMA acknowledged such concerns but still highlighted the need to avoid misleading investors (ESMA, 2024b, pp. 12). As a result, on December 14, 2023, it announced a substantial shift, abandoning the 50% threshold (ESMA, 2023a, pp.1). Instead, it adopted a more subjective approach, requiring funds to commit to “invest meaningfully” in Sustainable Investments, while implicitly leaving the interpretation and enforcement to the NCAs (ESMA, 2024b, para(s).22-23).
The rationale for this modification was clarified later on in a Q&A response published on December 13, 2024, addressing whether a minimum investment level should be required for funds “to be considered as investing meaningfully in sustainable investments” (ESMA, 2024c).
In its response, ESMA stated that NCAs should assess sustainability-linked named funds on a case-by-case basis, noting that: i) they may find that investments below a 50% threshold may not meet the “meaningful commitment” criteria, and ii) higher thresholds could be required depending on the circumstances (ESMA, 2024c).
To our consideration, this position relativizes the use of sustainability-linked terms when naming funds. Although ESMA discreetly pointed out the 50% threshold, its explicit omission in the Guidelines allows for fragmented applications of the term “meaningful investment” across NCAs’ jurisdictions. This could also lead to inconsistent practices, even within a given jurisdiction due to the case-by-case approach by NCAs.
In today’s sustainable market, where Light Green funds have been marketed with questionable sustainability claims, an objective threshold could have prevented greenwashing risks and indiscriminate use in the market. By replacing it with a subjective “meaningful investment” criterion, ESMA missed an opportunity to provide clearer safeguards against such practices.
Notwithstanding this, while we agree with the previously mentioned concerns regarding the confusion surrounding the definition of Sustainable Investments and the diverse methodologies used by asset managers, the subjective criteria of “meaningful investment” further relativizes the available market information. In this context, less strict measures, such as specific Q&A with ESMA, could have helped clarify definitions and methodologies to be considered in the sustainable market.[3]
Finally, though the unattainability of sustainability-linked names for funds posed challenges for the sustainability fund market, other measures could have been implemented. For example, maintaining the objective threshold with a longer transition period (to allow for portfolio adjustments) and/or applying case-by-case analysis only in exceptional instances of non-compliance, could have better supported the goal of true sustainability.
Still, the key question remains as to whether regulators should prioritize the proliferation of sustainable-linked named funds or set a higher standard that would protect the sustainability expectations of the investors. In terms of transparency and investor protection, the latter option may be preferable.
Conclusion
The Guidelines represent an important step toward addressing greenwashing in the EU market. However, they remain an isolated effort within a broader regulatory framework that structurally allows greenwashing risks associated with Light Green financial products.
While the Guidelines attempt to address some of the core greenwashing risks, particularly through the EU Paris-aligned Benchmark exclusion list, they ultimately fell short of providing a comprehensive solution.
By favoring a more flexible approach to meaningful investment in Sustainable investments, ESMA has postponed the establishment of an objective threshold that could ensure clear, fair, and non-misleading fund naming.
Instead, the responsibility for defining what a meaningful commitment has been delegated to the NCAs, which could lead to inconsistent interpretations across jurisdictions. The result is the potential risk for a regulatory arbitrage scenario, which could be exploited against the sustainability preferences of the investors.
In that regard, it could be considered that greenwashing risk in the market may remain a significant challenge in the near future, partly due to this half-measure approach. Without a clear objective threshold, the proliferation of inaccurate sustainability-linked named funds may continue to mislead investors, ultimately hindering progress toward genuine sustainability in the EU market.
~ Diego Liendo Ganoza (Corporate & Financial Law LLM Student)
Bibliography
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[1] The Guidelines apply in the EU jurisdictions where national competent authorities (“NCA”) have notified their intent to comply through their incorporation into their legal and supervisory framework (ESMA, 2024b, para(s)10-11).
[2] For example, some methodologies may not consider a company as a “whole” as a Sustainable Investment, but in part (ESMA 2024a, pp.36).
[3] For an absolved consultation over a whole-company-approach of Sustainable Investments, please visit: https://www.eiopa.europa.eu/document/download/de2ef448-5638-4b07-b493-259e109e35c2_en?filename=JC-2023-18-Consolidated-JC-SFDR-QAs.pdf (pag.7).
