The European Securities and Markets Authority (ESMA) is set to introduce rules on how asset managers should name their ESG-related funds in a bid to protect investors and stamp out greenwashing.

In draft guidelines published on Friday, Europe’s financial market regulator said it wanted to “address any misuse” of the Sustainable Finance Disclosure Regulation (SFDR) which has been used as a “powerful marketing tool” by asset managers.

Under the proposals, funds labelled ESG should have a sustainable investment threshold of 80% while funds labelled sustainable should have at least 50% invested sustainably.

The regulator said the thresholds will be based on the definition of sustainable investments under the SFDR.

In addition, “minimum safeguards” will apply to funds using exclusion criteria while additional considerations will be applied for index and impact funds.

“With this consultation, ESMA continues to prioritise promoting transparency and tackling the risk of greenwashing as identified in the ESMA strategy and sustainable finance roadmap,” Verena Ross, chair of ESMA, said.

“The objective is to ensure that investors are protected against unsubstantiated or exaggerated sustainability claims while providing asset managers with clear and measurable criteria to assess names of funds including ESG or sustainability-related terms.”

ESMA is seeking industry feedback on the guidelines by February, with the view of implementing the rules three months after it has finalised its response.

The new rules are set to majorly impact how funds are classified under SFDR, with funds likely to have to change their name or enhance their strategy in a bid to meet the new requirements.

Analysis by Morningstar on ESMA’s proposals found that just 18% of ‘light green’ Article 8 funds would be eligible to use the word “sustainable” in their fund name.

This rises to 80% for ‘dark green’ Article 9 funds.

Antonio Barattelli, head of the investment management unit at ESMA, said: “ESMA believes that when ESG or sustainability-related terms are used in a fund’s name, this should be supported in a material way by evidence of sustainability characteristics or objectives that are reflected fairly and consistently in the fund’s investment objectives and policy.”

The consultation comes at a crunch time for sustainable investment funds in Europe ahead of the introduction of ‘level 2’ of SFDR in January.

Asset managers have been downgrading their ETFs from Article 9 to Article 8 at a rapid pace. BlackRock, UBS Asset Management and Invesco all announced downgrades to their Paris-Aligned (PAB) and Climate Transition Benchmark (CTB) ETFs earlier this month.

Last week, the European Supervisory Authority (ESA) launched a call for evidence to better understand the level of greenwashing across the sustainable investment value chain.

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