The story of investment in the twenty-first century so far has been the story of sustainable investment. The Global Sustainable Investment Alliance estimates that at the beginning of 2020, sustainable investment worldwide was worth $35.3 trillion. And, despite recent years havin seen ESG investing dragged into the political debate, this trend is unlikely to disappear anytime soon.
This is because, away from the heat and noise of politics, retail investors want to invest in ways which generate returns, but which don’t cost the earth. And this appetite is driving institutional investors too via pension schemes, shareholder activism and a growing awareness amongst businesses of the obligations they have to our shared environment.
As younger cohorts of investors come online, this trend is only likely to grow.
It’s estimated that millennials have contributed more than $50 billion to sustainable funds since 2020. Furthermore, around 40% of Gen Z want to invest in ‘companies with purpose’ and it’s expected that, by next year, 33% of global assets under management will be ESG aligned. So, whether it’s ESG, or whether it’s ‘transition investing’ as per the recent intervention from Blackrock, sustainable investing is here to stay.
With sustainability being so close to many investors' hearts, and with huge capital flows in play, it’s therefore crucial that investment funds do what they say on the tin, when it comes t sustainability.
Recent years have seen growing awareness of ‘greenwashing’. This saw businesses stoking investor appetite with inflated claims about sustainability credentials which couldn’t always be backed up. In the world of investing we likewise now have a plethora of funds to choose from, many of them making claims about sustainability. But how robust are these claims?
To give investors confidence in this area, the European Securities and Markets Authority (ESMA) consulted on guidelines around fund names when those names make claims about ESG and sustainability. These guidelines will eventually apply to UCITS management companies, alternative investment fund managers and managers of European Venture Capital Funds and European Social Entrepreneurship Funds.
So, what will the likely outcomes of this consultation be, and how can both investors and fund managers prepare?
A sustainable approach to regulation
While the guidelines are yet to be finalised, there are a number of measures proposed that fund managers can begin to consider now, especially if making claims about sustainability, ESG and related terms. Overall, the objective of the new guidelines is to ensure that names given to funds in fund documents and marketing doesn’t mislead.
We can anticipate a significant surge in the demand for substantiated claims suggested by fund names. With extensive groundwork already laid in the investment sector for the EU’s Sustainable Finance Disclosures Regulation (SFDR) and global ESG regulations, there's optimism that fund managers will swiftly adapt to building this evidence base. Initiatives such as Fund Labelling in the UK, a regulatory endeavour aimed at aiding consumers in navigation and fostering trust with the introduction of four distinct labels—Sustainability Focus, Sustainability Improvers, Sustainability Impact, and Sustainability Mixed Goals— will further streamline the adaptation process for fund managers.
Fund managers can also expect some further, more specific guidance about what will be expected when it comes to evidencing claims. Funds claiming to be ESG aligned will need to demonstrate that 80% of investments comply with environment and social standards defined under the SFDR. Any fund making claims about sustainability should be able to demonstrate that half of the 80% allocation to ESG investments is related to sustainability.
Alongside these positive requirements, ESMA’s new guidelines will also likely include a range of prohibitions for funds claiming to be sustainable and ESG aligned. Such claims will be considered misleading if the fund is invested in a whole range of sectors including tobacco, coal and oil fuels and controversial weapons.
All of this is designed to ensure that investors looking to invest sustainably, can be assured that their money isn’t supporting enterprises that would seem to be contrary to sustainable growth and the energy transition. For fund managers, it will mean an opportunity to audit fund allocations and ensure that the language being used to describe the fund is an accurate reflection of reality.
We’ve already seen ESMA levelling fines against businesses for greenwashing, so the investment community would be wise to ensure compliance with the new rules, before they go live sometime later in 2024.
While the adoption of the forthcoming ESMA´s new guidelines will follow the review of the AIFMD and UCITS Directive, it is important to emphasise their immediate significance. The unleashing of these guidelines will notably improve transparency for investors and strengthen their confidence, therefore the importance of acting swiftly to avoid any delay with their release.
* This article was first published in Investment Week, on April 16 2024
