ESMA publishes Q&A on its Fund Naming Guidelines

Application of PAB/CTB exclusions to green bonds and other use of proceeds bonds

Question: When applying the exclusions referred to in paragraphs 16-18 of the guidelines, can fund managers consider the underlying project for use of proceeds instruments or should the manager always consider the whole issuer?

Answer: With regard to European Green Bonds that have been issued under the European Green Bonds Regulation (Regulation (EU) 2023/2631), investments in such instruments do not need to be assessed under the exclusions of investments referred to in paragraphs 16-18 of the Guidelines, because the Guidelines are intended to be read in conjunction with Level 1 legislation such as the European Green Bonds Regulation and should consider the high level of protection guaranteed by the EU legal framework for such investments.

With regard to investments in any other type of use of proceeds instruments, such as green bonds not issued under the European Green Bonds Regulation, the exclusions referred to in paragraphs 16-18 of the Guidelines should apply on a look-through basis to the economic activities financed by such instruments. The look-through approach should determine that the instrument invested in does not finance any activities referred to in Article 12(1)(a-b) and (d-g) of Commission Delegated Regulation (EU) 2020/1818. Investments in companies excluded under Article 12(1)(c) of Commission Delegated Regulation (EU) 2020/1818 would not be able to benefit from this look-through approach (i.e. those companies are always excluded under the exclusions referred to in paragraphs 16-18 of the Guidelines).

Since the Guidelines were finalised in May 2024, industry has been grappling with how a fund using an in-scope term in its name should comply with the PAB/CTB exclusion criteria in the context of green bonds and other use of proceeds instruments whose proceeds are specifically used to finance environmental  projects.

In the case of investment in green bonds issued under the EU green bond framework, ESMA confirms in the Q&A that no assessment against the PAB/CTB exclusion criteria must be carried out.  As it stands, this is likely to be of limited relevance to fund management companies given the relatively low number of bonds expected to be issued under the EU green bond framework when it takes effect this month but this is likely to change over the coming years as the number of issuers using the framework grows.

However in a move likely to be welcomed by those funds using in-scope names and implementing bond strategies focused on bonds falling outside of the EU green bond framework, ESMA has clarified that it is possible to comply with the PAB/CTB exclusion criteria by confirming that the investment held by the fund does not finance any of the excluded activities rather than being required to apply the exclusion criteria to the issuer as a whole. This clarity means that funds using in-scope names can continue to support those companies transitioning to more sustainable business practices by providing them with important funding sources. 

The only exception to this “look-through” approach is that in-scope funds must ensure that they do not invest in companies found to be in violation of the UN Global Compact principles or OECD Guidelines for Multinational Enterprises.

“Meaningful investment” in sustainable investments by funds using a sustainability-related term in their name

Question:  Is there a minimum level for investment funds with the term “sustainable” in their name to be considered to be investing “meaningfully” in sustainable investments?

Answer: The third indent of paragraph 18 of the Guidelines foresees that funds using “sustainable” terms should commit to invest meaningfully in sustainable investments referred to in Article 2(17) of the SFDR. While national competent authorities should carry out a case-by-case analysis of how any sustainability-related term is used in the name of a fund, they may find that investment funds with "sustainable" terms in their names investing less than 50% of the proportion of investments in sustainable investments are not "meaningfully investing in sustainable investments". That amount could be higher, subject to the circumstances of the case.

ESMA had originally proposed a 50% threshold of investment in sustainable investments for funds using a sustainability-related term in their names in its consultation on naming guidelines issued in November 2022. Acknowledging feedback from stakeholders to that consultation, it decided to drop that 50% threshold in the finalised Guidelines and to replace it with the concept of “meaningful investment” in sustainable investments.

However, addressing a concern on the likelihood of a diverging interpretation of the term “meaningfully invest” by national competent authorities which could significantly negatively impact the cross-border sale of funds, ESMA has now provided some clarity around the concept of “meaningful investment” and indicated in its Q&A that funds using a sustainability-related term in their name should invest at least 50% of investments in sustainable investments. The Q&A does however leave the door open to a national competent authority imposing a higher threshold or permitting a lower threshold than 50% on a case-by-case basis.  

Meaning of the term “controversial weapons” in the context of the PAB/CTB Exclusion Criteria

Question: How should the exclusions related to controversial weapons referred to in Commission Delegated Regulation (EU) 2020/1818 be interpreted for different types of controversial weapons?

Answer: For the purpose of applying the exclusions referred to in paragraphs 16-18 of the Guidelines related to Article 12(1)(a) of Commission Delegated Regulation (EU) 2020/1818 (companies involved in any activities related to controversial weapons), national competent authorities may, in the absence of any other clarification in that Delegated Regulation, refer to the list of controversial weapons provided in indicator 14 of Table 1 of Annex I of Commission Delegated Regulation (EU) 2022/1288, namely “anti-personnel mines, cluster munitions, chemical weapons and biological weapons”. 

Again addressing a question that has been raised by many fund management companies since the Guidelines were published, ESMA has confirmed that this term should be understood as including anti-personnel mines, cluster munitions, chemical weapons and biological weapons. Helpfully, this description is consistent with the definition of “controversial weapons” used in both the SFDR and the CSRD frameworks.