European regulators are tightening the reins on investment funds using ESG labels in their names. The European Securities and Markets Authority (ESMA) released finalized guidelines to prevent “greenwashing,” where funds exaggerate their sustainability credentials to attract investors.

The move comes amid a surge in investor demand for ESG-focused funds. ESMA found a fourfold increase in the use of ESG terms in European fund names over the past decade. However, this has led to some asset managers misleadingly labelling funds as “sustainable” to attract investors, which amounts to greenwashing.

The new guidelines establish clear thresholds for using ESG and sustainability labels. Funds using “sustainable” in their name must invest at least 80% of their assets in sustainable investments, with a commitment to further increase this focus over time. Exclusions similar to those used in the EU’s Paris Aligned Benchmarks, which restrict investment in high-emitting companies, will also apply.

Responding to investor feedback, ESMA included a new “transition” category for funds supporting companies moving towards sustainability. These funds can use terms like “improving” or “transformation” in their names, but are still subject to an 80% investment threshold, with exclusions based on the EU’s Climate Transition Benchmarks, which allow for some investment in fossil fuel companies on a path to transition.

“These guidelines aim to ensure clarity and comparability for investors,” said an ESMA spokesperson. “Investors should be confident that a fund’s name accurately reflects its investment strategy.”

The new guidelines will be translated into all EU languages and take effect three months after publication on the ESMA website.

Click here for new ESMA guidelines.

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