ESG and sustainability fund names under review

© Pedro Henrique Santos

ESMA, the European Securities and Markets Authority initiated a consultation until 20 February 2023 to develop guidelines on funds’ names with ESG or sustainabilty-related terms.

One of the challenges will be to define the level of ESG factor integration in the investment process of a particular fund. How would one measure this level over time?

The EU taxonomy is of limited help at this stage as it is not yet fully defined and levels of taxonomy-alignment will develop alongside the taxonomy itself. Today most asset managers disclose such low levels of % taxonomy alignment which cannot be used for fund name rules.

SFDR self-classifications of asset managers and interpretations of the term ‘sustainable investment’ is also not the best and most reliable basis for fund name rules. The DNSH concept might assist in assessing the qualitative characteristics of a fund but will itself not be sufficient as a reliable guidance for fund name definitions.

Similar to the 80% rule in the U.S. a fund name rule along this line cannot be ruled out in Europe. The “Names Rule” is under review in the U.S. also. It requires funds with certain names to adopt a policy to invest 80 percent of their assets suggested by that name. This applies to terms like “growth” and “value” but should also cover strategies that relate to one or more ESG factors.

How to track a qualitative factor in a quantitative context

The name of a fund is a qualitative factor. If a % rule for required sustainable investments in a fund with ESG or other sustainability terms in the name would apply this would need to be calculated. Investee companies would have to be classified somehow and asset managers would need to monitor the fund or portfolio taking the name rule into account.

To ensure compliance with potential %-based fund name rules a real-time monitoring of sustainalbe investments in a fund is required. This is a quantitative process and needs to be fully digitised. It would require individual holdings to be rated in an ESG and sustainability context internally by the fund manager or externally by third parties.

Standardising of strategies could limit fund managers

To support the monitoring process asset managers might tend to standardise investment strategies. But the process of standardising ESG investment strategies to comply with certain fund name rules might restrain the flexibility of asset managers to apply their own proprietary investment processes, as warned by attorney Claire Pagnano of K&L Gates in an article published by Forbes in the U.S.

An even bigger risk is that many nuances in ESG investing and the interpretation of sustainability terms by asset managers will be harmonised and a lot of information will be lost along the way.

Applying the 80 percent rule in ESG and sustainability investing might force fund managers to change their strategy and prevent them from applying unique insights in mutual funds. There should be more flexibility on the institutional investment side as mandates and institutional funds can be customized to clients’ needs and preferences.

Active fund management strategies are unique by definition and the fund manager might have specific reasons for including or not including companies in a fund.

Bryan Junus, chief analyst of The Corporate Citizenship Project warned about the complexity of definitions and the expansion of the 80% rule (U.S.) to ESG funds. A climate change fund manager could invest in a video production company which itself might not be classified as sustainable but would benefit from reduced personal travel activity due to climate change concerns or higher travel costs. It might be the case that the video production company would fall outside the 80% rule but should actually be seen in combination with the underweighted travel stocks in the portfolio and in the context of the overall portfolio.

Risk for misinterpretation and greenwashing

Isn’t the obove mentioned loss of nunances in investment strategies and communication of fund manager activities the biggest risk for misinterpretation and misselling?

When fund managers are limited too much by harmonised descriptions and fund name rules the risk of unintended greenwashing increases. This should be considered by regulators and supervisory authorities as part of the review of fund name rules.

ICI critisizes the SEC Fund Name rules as controversial

ICI (Investment Company Institute) issued a statement and raised concerns as follows: “Prospective investors understand that a name is simply a starting point for understanding the fund’s investment strategies. In addition to the name, there are extensive documents prepared by funds describing their strategies, objectives and holdings. The SEC now wants a fund’s name to stand alone, despite all this comprehensive disclosure. The SEC’s names rule proposal is a blunt instrument that would place enormous costs on funds to comply with this new, complex regime. These costs will ultimately be paid by investors. The proposal also places the Commission in the position of second-guessing how investment professionals choose investments and execute strategies. This is not the SEC’s job.”

Fund management companies raised concerns as index managers would need to monitor each security in the index continuously (to calculate the compliance with ESG and sustainability index/fund name rules which could be seen as making the strategy active to a certain extent and the efficiency benefits of passive management were gone. It might also be too complex to adjust the index based on the development of stocks within an index when an 80 % rule would have to be followed.

On the other side the risk of limiting the flexibility of active investment strategies of asseet managers could make them more passive.

The FCA (Financial Conduct Authority) in the UK already informed Authorised Fund Managers (AFM) in a letter in 2021. A fund’s ESG/sustainability goal should be reflected consistently in the fund’s design, delivery, and disclosure. This should capture the fund’s name, stated objectives, documented investment policy and strategy, and its holdings.

In the letter to Authorised Fund Managers (AFM) Principle 1 was described as one including the design of responsible or sustainable investment funds and disclosure of key design elements in fund documentation. References to ESG (or related terms) in a fund’s name, investment policy, financial promotions or fund documentation must not be misleading and should fairly reflect the materiality of ESG/sustainability considerations to the objectives and/or investment policy and strategy of the fund.

Using terms like “sustainable”, “ESG”, “responsible” or related terms in a fund’s name can be misleading in the FCA’s view unless the fund has a substantive focus on ESG or sustainability that is material to the fund’s objectives and strategy. The FCA expect the investment strategy of funds that pursue ESG/sustainability characteristics to include key elements of the strategy, such as the specific E/S/G themes or “real world” (non-financial) impacts and (positive or negative) screening criteria. The FCA would not expect to see prominent ESG claims in fund documents, or ESG positioned as a key part of the fund’s offering, where the fund integrates ESG considerations into mainstream investment processes (i.e. where there is no material ESG orientation in the specific fund’s design or strategy).

More recently the FCA also launched a consultation paper and stated the following: “We are concerned that firms are making exaggerated or misleading sustainability-related claims about their investment products; claims that don’t stand up to scrutiny (greenwashing). This may lead to consumer harm and erode trust in the market for sustainable investment products. Our proposals aim to build transparency and trust by introducing labels to help consumers navigate the market for sustainable investment products, and ensuring that sustainability-related terms in the naming and marketing products are proportionate to the sustainability profile of the product. We are also proposing disclosure requirements, including accessible consumer-facing disclosures informed by behavioural research (Occasional Paper 62), as well as more detailed product- and entity-level disclosures.

Our proposals focus on asset managers and their UK-based fund products and portfolio management services. We will look to expand and evolve the regime over time.

We are also proposing an ‘anti-greenwashing’ rule that would apply to all regulated firms, reiterating that sustainability-related claims must be clear, fair and not misleading.” The consultation will close on 25 January, 2023.

Future Fund Name Rules

Investment fund name rules are under review in the U.S. in the UK and in Europe. New labels might be introduced also in combination with new fund rules. The 80% fund name rule in the U.S. and its extension to ESG creates challenges as described above.

Market participants hope that potential new rules are introduced on the basis of a fair assessment of the overall benefits and costs involved across market segments and that the views of market practitioners on the asset owner and asset manager side are considered.


All opinions expressed are those of the author and/or quoted sources. is an independent and neutral platform dedicated to generating debate around ESG investing topics