ESMA Greenwashing Rules and Regulatory Overreach
We haven’t had to wait too long before receiving some official feedback on one of the most recent endeavours carried out by ESMA – the consultation on ESG fund names. In its advice, released just before the end of February this year, the Securities and Markets Stakeholders Group (SMSG) officially expressed its views on the merits – and mostly the limits – of the proposed new ESMA greenwashing rules. Before talking in more details about these, it is noteworthy to point out one of the most awkward comments raised in this advice. When comparing the proposed ESMA greenwashing rules to a similar exercise carried out by the ESAs, the SMSG observes that, to the contrary of the ESAs, ESMA had not received in that instance any formal mandate by the European Commission to propose new rules.
Moving on from this apparent questioning of the fundamental why of the proposed ESMA greenwashing rules, which the SMSG was not shy to criticise for other reasons, we gather that there seems to be an agreement in principle on the merit of the proposed rules. Yet, the SMSG appears not to be overly impressed both with the methodology adopted by ESMA and the potential outcomes of the proposed rules and believes that more and different measures are required to tackle the risk of greenwashing.
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Quantitative Thresholds and Retail Confusion
The approach proposed by ESMA is mainly centred on the introduction of quantitative thresholds for funds intending to use ESG or sustainable terms in their names. Such use should be possible when the minimum proportion of investments of the related fund portfolio is in line with the quantitative thresholds proposed with the ESMA greenwashing rules. For the use of sustainability-related terms, instead, an additional quantitative threshold is applied.
The SMSG has a different set of reasons to criticize this approach. On the one hand, it purports that we are still too early in the process for having a sufficient degree of clarity on concepts like ESG and sustainable investment in order to be able to have common definitions. And that is the issue at hand, which makes quantitative approaches like the one proposed by ESMA less resolutive of current greenwashing risks in the eyes of the group. Also – should the quantitative approach be looked at theoretically as a viable solution – ESMA did not make clear the calculation basis of the potential thresholds. Calculations should not be made at AUM/NAV but rather on the exposure value of the investment portfolio. Should that not be possible, the threshold should consider the investable universe after having removed 20% corresponding to liquid ancillary assets. That would allow for comparing funds more efficiently.
Lastly, the SMSG believes that retail investors do not yet have a developed taste and understanding of these investment products. Introducing a distinction between ESG and sustainability-related terms will only generate confusion and so the two related quantitative thresholds.
The Issue with Exclusion Strategies
Unsurprisingly so, a substantial part of the SMSG advice – and the criticism towards the proposed ESMA greenwashing rules – is centred on the concept of exclusion strategies. The group sustains that the quantitative threshold approach brought about under the ESMA greenwashing rules validates only the existence of exclusion strategies under the paradigm of ESG and sustainable investing.
As we saw, instead, the SMSG purports that the industry would rather benefit at this stage from a better clarification of the key ESG investment approaches and strategies, for instance, along with an indication of the respective characteristics. In other words, in order to obtain the right to refer to ESG and sustainability in the name of a product, a fund manager or promoter should be able to demonstrate effectively how ESG manifests itself in the management of the fund. That can be done – and should be done in the eyes of the SMSG – by adherence to the main criteria of a certain ESG/sustainability strategy (e.g. engagement, relative rating improvement, relative selection approach) rather than merely on exclusion strategies linked to a specific quantitative threshold of investments in the portfolio.
Conclusions
It is rare to see such multidirectional criticism towards one single piece of rules. Whilst we can agree that we are still very early in the process of ESG and sustainable investing, the SMSG points out very eloquently the limits of ESMA in its monodirectional and quantitative approach to the proposed rules. What seems to emerge clearly is that ESG and sustainable investing should be multifaceted and not merely expressed based on exclusion strategies. The suggestion made by the SMSG to introduce categories for what ESG and sustainable investing should look like is welcome and hopefully received soon by ESMA too.
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