BaFin Consultation on Guideline for Sustainable Investment Funds

On 2 August 2021 the German Federal Financial Supervisory Authority (BaFin) has published a draft guideline for sustainable investment funds as part of a public consultation process. The guideline sets out how certain German investment funds must be structured so that they qualify as “sustainable” or can be marketed as “sustainable” in Germany.

Background and scope of application

The guideline intends to set clear requirements for sustainable investment funds in order to prevent greenwashing. BaFin refers to its competence to create guidelines under section 4(2) German Capital Investment Code (KAGB), which enables BaFin to set standards for certain fund categories to supplement and clarify the legal requirements for such fund categories as well as to ensure that such categorizations are not misleading. BaFin also makes reference to Regulation (EU) 2019/1156 on facilitating cross-border distribution of collective investment undertakings, which could lead to the conclusion that the guidance also relates to EU and non-EU investment funds when marketing such investment funds into Germany. Notwithstanding this reference, BaFin explicitly states that the guidance only applies to domestic public investment funds (inländische Publikumsinvestmentvermögen), i.e. German retail AIFs and UCITs.

BaFin emphasises that the guideline shall not affect the European legal framework, i.e. the Sustainable Finance Disclosure Regulation (SFDR) and the Taxonomy Regulation, and points out that these instruments focus on disclosure and transparency regarding the integration of sustainability risks and adverse sustainability impacts as well as sustainable investment objectives, but do not include further quantitative or qualitative standards. To fill this gap, BaFin’s guideline regulates the use of designations which indicate that a product is “sustainable” and create requirements for such product’s investment terms (Anlagebedingungen). If the European Ecolabel is expanded in the future to also include investment funds, BaFin will adapt its guideline accordingly.

Requirements for sustainable investment funds

The guidance relates to investment funds whose name includes a reference to sustainability (e.g. “ESG”, “green”, “sustainable”) or which are explicitly marketed as “sustainable” in the prospectus or other marketing materials and includes the following three options how the investment terms of such investment funds need to be drafted.

Quota of sustainable investments

In case the fund’s sustainability objective includes a minimum quota of sustainable investment, such quota may not be lower than 75% of sustainable investments, as such term is defined in the SFDR. Compared to a previous informal draft of the guideline, BaFin has lowered this threshold from 90% to now 75% in the current guideline. Furthermore, the fund’s investment strategy shall ensure, e.g. through investment restrictions or additional sustainability criteria, that (i) a significant contribution is made to the realisation of one or more environmental or social objectives, (ii) other environmental or social objectives are not significantly harmed and (iii) good governance aspects are taken into account. In this context BaFin requires the investment terms to specify that the issuers of portfolio investments and/or portfolio companies may not generate revenue from

• energy production from fossil fuels (excluding gas) or nuclear power exceeding 10% of their total revenue;
• exploration for or extraction of oil or coal exceeding 5% of their total revenue; and
• extraction of and services for oil sands and oil shale.

When interpreting the above criteria and objectives, BaFin intends to be guided by the SFDR and the Taxonomy Regulation.

Sustainable investment strategy

If no fixed quota of sustainable investments is included as an investment limit, an investment fund can also qualify as a sustainable investment fund under BaFin’s guideline if it pursues a sustainable investment strategy, for example by following a "best-in-class strategy" or by providing that at least 75% of the assets are selected based on sustainability criteria (without such assets having to qualify as sustainable investments) and that such sustainability criteria are of decisive importance for the selection process. The sustainable investment strategy is to be described in detail in the investment terms.

Sustainable index

If, according to the investment terms, a sustainable index is replicated as part of a passive investment strategy, more detailed information on the sustainable nature of such index is required. Furthermore, investment limits should be included to ensure that environmental and social objectives are not significantly harmed and that good governance aspects are considered.

Timing

The guideline includes a grandfathering provision whereby the guideline’s requirements do not apply to investment funds whose investment terms have already been approved by BaFin at the time of the publication of the guideline. The consultation process for the guideline is open until 6 September 2021. BaFin does not explicitly state from when the guideline will apply. We expect BaFin to clarify this point following the end of the consultation process when publishing the final guideline or confirming that no changes will be included in the guideline.