On 31 May 2022, the European Securities and Markets Authority (ESMA) published a supervisory briefing on sustainability risks and disclosures in the area of investment management. 

The aim of these types of supervisory briefing is to promote supervisory convergence such that the relevant regulatory requirements are applied consistently across the EU. Whilst in formal terms such briefings are neither binding nor subject to a “comply or explain” mechanism for NCAs, they nevertheless inform supervisory practice.

Much of the briefing is unsurprising in terms of explaining (albeit in plainer English) details we already knew about the SFDR. However, there are a few interesting points to note:

Product level PAI

ESMA confirms the pre-contractual SFDR disclosures which, as a minimum, NCAs should verify, and in this list, ESMA confirms that they expect Art. 9 SFDR products to give a “positive” product level PAI disclosure (i.e. that they consider PAIs at a product level) under Art. 7 SFDR due to the requirements of the PAI based DNSH test in the Level 2 rules (which require the disclosure of how the indicators for adverse impacts in Annex I of the Level 2 rules have been taken into account, and because Art. 9 SFDR products should only make sustainable investments”).

Fund names 

Overall, the briefing in this context suggests there will be a greater focus on fund names from NCAs in future, and seems to be largely consistent with the guidance and upcoming reforms from the UK's FCA and the US' SEC on ESG naming conventions.

NCAs are encouraged to check the consistency of the:

  • way the sustainability-related disclosures are presented;
  • fund’s name;
  • investment objective and policy; and 
  • investment strategy.

In addition to this, there is a whole section of the briefing devoted to giving “principles-based guidance on fund names”. This raises a few interesting points:

  1. ESMA notes that there are no legal grounds under the SFDR to prohibit an Art. 8 fund without sustainable investments from using the terms “sustainable” or “sustainability” in its name, but ESMA thinks that to avoid confusion the terms should only be used by Art. 9 funds, Art. 8 funds which “in part invest in economic activities that contribute to environmental or social objectives”, or Art. 5 TR funds (although of course this latter category is just a sub-category of Art. 9).
  2. The reference to Art. 8 funds is interesting, in that it does not explicitly refer to Art. 8+ funds or the concept of sustainable investments, but rather to fund investments that “contribute to environmental or social objectives”. It is unclear whether this is a deliberate distinction that is being made (i.e. that a fund can invest in “sustainable” things without them being “sustainable investments”, and the intention is just to carve out Art. 8 funds with basic exclusions etc. from using the terms “sustainable” or “sustainability”) or whether ESMA meant to refer to Art. 8+ funds. Based on the text, it seems possible to argue that Article 8 funds can use the term “sustainable” in their name, provided they can demonstrate a positive ESG tilt or consideration, and the examples ESMA has provided indicate that an Art. 8 fund that just uses exclusions to meet its E/S characteristics should not use the term “sustainable” in its name.
  3. Similarly, the words “impact”, “impact investing” or similar impact terms “should only be used by funds whose investments are made with the intention to generate positive, measurable social and environmental impact alongside a financial return”. This is also consistent with the feedback given by the FCA and the SEC in their respective proposals.
  4. Index tracker funds could use “any ESG-related terms if the index the fund designates is itself ESG-focussed” provided that it is not just excluding “a small number of securities” and does not just have holdings that “are not materially different form a similar non-ESG index”.

ESMA then goes on to give some examples of acceptable and unacceptable names in paragraph 31.

Presentation of SFDR disclosures

In emphasising that disclosures should be clear, succinct, fair and not misleading, ESMA notes that:

  1. Sustainability-related disclosures should not include boilerplate language with complex legal disclaimers, nor technical jargon that might not be understood by the average investor. A warning sign for supervisors should be the repeated use of the same or similar standard text across different funds”.
  2. In their view, sustainable objectives or characteristics should be clearly identified and expressions such as “the fund pursues ESG objectives in general” without further specificity should be avoided.
  3. Cross-references and hyperlinks should be limited to the ones required by the “Where can the methodology used for the calculation of the designated index be found?” and “Where can I find more product specific information online?” sections of the RTS templates.
  4. Whilst disclosures should give “an indication as to under which Article of SFDR (and if relevant, the TR) the UCITS/AIF discloses”, this should be “Without giving the impression of a “label” to investors”  - one could say that this emphasises the point that Articles 8 and 9 should preferably be described as disclosure requirements rather than “labels” or perhaps even “categories” . However, in practice, this will likely just result in these categorisations being treated even more as a label.

Interplay between AIFM / UCITS rules and SFDR disclosures

ESMA suggests NCAs should verify the compliance of AIFMs and UCITS ManCos with the new AIFMD and UCITS sustainability risk integration rules by checking their entity and product level SFDR disclosures.  A list of policy and procedures that might be impacted by these rules is also provided in paragraph 55 – and this could be a useful cross-check for implementation of the AIFMD / UCITS requirements.

Interplay with and expectations from depositaries

In a few places, ESMA has suggested that NCAs should involve depositaries in their supervision and oversight of AIFMs and UCITS ManCos. ESMA has also clearly articulated that all relevant information (including on ESG matters and ESG related investment restrictions) should be provided by UCITS ManCos and AIFMs to the depositary to enable the depositary to effectively perform its depositary functions.

Enforcement suggestions

In order to combat greenwashing, ESMA suggests enforcements “may be appropriate to consider” in the following non-exhaustive examples:

  • Legally required SFDR disclosures have not been made at all.
  • SFDR disclosures are “severely misleading”.
  • Sustainability risks have not been integrated throughout the organisation of an AIFM / UCITS ManCo.
  • Periodic disclosures do not match “or fulfil” Art. 8/9 characteristics/objectives.
  • An Art. 9 SFDR products shows in periodic disclosures “that significant proportions of investments” are not sustainable investments. (This reinforces previous guidance that close to 100% of Art. 9 fund investments should be sustainable investments but is also interesting because a “significant proportion” would have to not be invested in sustainable investments to merit enforcement in ESMA’s view – and the delta between that and 100% sustainable investments could well be quite significant. However, nevertheless we think firms should generally aim to have 100% sustainable investments in Art. 9 funds.)

However, ESMA has also stated that NCAs should be proportionate in their supervision in this context.

Continued uncertainty?

In addition to what ESMA does say, there are some interesting things it does not say. Notably,  ESMA  does not explicitly deal with the  question of whether, and how, Art. 42 AIFMs are in-scope of SFDR requirements (which may mean that an uneven and unclear approach persists in this area across NCAs and in the EU).

You can read the supervisory briefing here.