In May 2024, the European Securities and Markets Authority (ESMA) defined the minimum criteria financial products must meet to be considered ESG-related. A newly released Q&A addresses previously ambiguous aspects.
Less Stringent Requirements for European Green Bonds
European green bonds will have fewer requirements to retain their sustainability label. Notably, green bond funds can continue investing in financial products from high-energy industries, such as utilities and major polluters. This exception diverges from the stricter ESG naming regulations outlined by ESMA, set to take effect at the end of November 2024.
On December 16, ESMA published an updated series of Questions & Answers clarifying the guidelines for ESG fund naming in Europe.
What Do the New ESG Fund Naming Rules Entail?
The revised ESG fund naming rules aim to curb greenwashing by tightening requirements for funds labeled as sustainable. ESMA’s criteria distinguish financial products into two key categories:
- Strong ESG Alignment: Investments with a robust focus on green initiatives, adhering to Article 8 of the Sustainable Finance Disclosure Regulation (SFDR).
- Moderate ESG Alignment: Investments with weaker ties to sustainability sectors, falling under Article 9 of the SFDR.
Published in May 2024, these rules require all new ESG funds to comply by November 21, 2024. Existing funds have until May 2025 to align. However, ESMA has provided limited clarity on which terms the changes affect. Research suggests a significant impact: an estimated 75% of funds previously categorized under Article 8 could face renaming or asset restructuring, according to Bloomberg analysis.
Key Clarifications in ESMA’s Q&A
ESMA’s Q&A primarily addresses concerns surrounding green bond classifications. The authority confirmed that European green bonds issued under the upcoming Green Bond Standard (launching December 21, 2024) are exempt from ESG fund exclusion rules.
This exemption prevents penalties for utility and high-energy companies issuing green bonds for sustainable projects. Companies in carbon-intensive sectors can issue green bonds without necessitating fund renaming or asset divestment. Notably, utilities and energy companies represent 20% of the global green bond market.
Evaluating Non-European Green Bonds
Non-European green bonds, or those issued by carbon-intensive companies, must be assessed using a “look-through” approach. This method ensures that bond proceeds fund activities meeting ESG criteria, even if the issuer does not fully comply with exclusion standards.
Additionally, ESMA’s Q&A establishes a 50% minimum threshold for sustainable investments in ESG funds, ensuring half of a fund’s portfolio aligns with sustainable activities.
