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Monday, December 4, 2023

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Sustainable funds naming regulations address twin challenge of greenwashing and ESG literacy, says lawyers

With the introduction of stricter naming guidelines for sustainable investment funds globally, ISFI spoke to lawyers in the space to understand why this is an area of regulatory priority and how the regulations attempt to combat greenwashing claims.

“In theory, the name of the fund should have little or no impact on the investors’ decision to allocate capital into the fund … The reality, however, is quite different. The name of the fund is the first feature that captures the attention of investors and is an important marketing tool that asset managers use to convey information about their funds to investors,” Malek Al Rifai, a partner at Al Tamimi & Company, told ISFI.

In February this year, Securities Commission Malaysia introduced a stricter naming convention for SRI funds in line with the ASEAN Sustainable and Responsible Funds Standards. In the same month, the European Securities and Markets Authority (ESMA) closed the consultation period for its guidelines on funds’ names using ESG or sustainability-related terms. Further, the UK’s Financial Conduct Authority closed its ‘Sustainability Disclosure Requirements (SDR) and investment labels’ consultation paper on the 25th January this year.

Malek suggests that the reason for international regulations converging on this issue is due to the significant amount of new private money earmarked for sustainability-related investments. He expects many new regulations to be issued in key markets across the world as regulators try to catch up with market developments.

While investors are expected to review a fund’s documentation and base their investment decision on its underlying fundamentals, regulators are concerned that some asset managers may use ESG and other sustainability-related names in connection with funds that do not necessarily meet the criteria for SRI.

According to Megat Hizaini Hassan, a partner at Lee Hishammuddin Allen & Gledhill, the introduction of stricter naming conventions is a preventative measure against greenwashing claims. “These measures help ensure that such ESG funds/products are not subject to accusations of greenwashing…,” Megat told ISFI.

While regulations play a vital role in preventing greenwashing claims, how new regulations fit in the existing regulatory landscape is also an important consideration.

“…Any regulation needs to work from a practical implementation and timing perspective for all market participants (including fund managers, asset managers and investors). Additionally, it is important that any guideline works with the existing and national regulations,” Asal Saghari, a counsel at King & Spalding, told ISFI.

With consumer protection at the heart of the greenwashing issue, the degree to which such guidelines should be applied to professional investors is also an area of contention. Asal understands from Alexandra Weis, a partner at King & Spalding’s Frankfurt office, that there are discussions in Germany to only apply the ESMA guidelines to retail funds.

“The idea being that professional and semi-professional investors are less in need of protection with regard to the application of fund names as [they are much more interested in the investment strategy and the structure of a fund],” Alexandra commented.
The regulations surrounding the naming of sustainable investment funds may relate to, in part, a lack of literacy with regard to sustainable terminology and investing.

In the International Capital Market Association’s response to ESMA’s consultation paper, it highlighted that the disconnect between a retail investor’s understanding of a sustainability label and the actual intended meaning of the label may be due to a lack of literacy rather than a result of intentional greenwashing by the fund manager.

Late last year, IFN spoke to Kristina Alnes, a director and the head of product at CICERO Shades of Green, an independent provider of second opinions on green bond frameworks, who contended that a lot of the greenwashing going on in the ESG space is due not to malicious intentions, but a lack of understanding. With the rapid development of the sustainable finance space and the top-down mandates for sustainable finance and development, we can expect to see continuous developments in the regulatory landscape.

According to Malek, the development and standardization of sustainable finance taxonomies, the integration of ESG risks in investment decisions and the third-party verification and audits of disclosed ESG-related information are regulatory trends to look out for in this space.

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