ESMA takes aim at greenwashing and SFDR disclosures just got indirectly stricter

On 31 May 2022, ESMA published a Supervisory Briefing aimed at ensuring convergence across the EU in relation to the supervision of investment funds and products which are in scope of the Sustainable Finance Disclosure Regulation ("SFDR") and the Taxonomy Regulation ("TR"). ESMA has published the briefing in an effort to combat greenwashing of investment products and funds by introducing common supervisory criteria to be applied by National Competent Authorities.

This is important because in some respects the supervisory briefing goes beyond what is set out in the SFDR and TR (and their level 2 measures). It also highlights the issues that are arising as a result of the divergence in current SFDR and TR disclosures. ESMA is clearly worried about the issue of greenwashing and the effect that the SFDR and TR is (or indeed is not) having on this practice.
The supervisory briefing forms part of a series of actions to implement ESMA’s February 2022 Sustainable Finance Roadmap. The document is focused on two key areas:

1. guidance for the supervision of fund documentation and marketing material; and
2. the integration of sustainability risks by AIFMs and UCITS managers.

The document is important for asset managers but also indirectly sell-side institutions in providing some context as to regulatory expectations on "greenwashing" and insights to factors that should be taken into account in terms of the product governance rules on sustainability. Funds ought to review their existing SFDR disclosures in light of the guidance and, where necessary, make relevant amendments to ensure that they are in line with ESMA and the NCAs' expectations in this area.

Key points raised

Marketing Material:

• Firms should consider the following in relation to marketing material in this area: the way sustainability disclosures are presented; the fund's name; investment objective and policy; and the investment strategy.
• Satisfying the fair and not misleading criteria under the SFDR will require avoiding boilerplate language with complex legal disclaimers and technical jargon, while also keeping cross-references and hyperlinks to a minimum.
• ESMA also provides principles-based guidance on fund names (i.e. terms such as ESG, social, ethical and impact should only be used if they can be backed up "in material way" and avoid using "impact" "impact investing" unless it really is impact investing).
• Sell side insight: the document is useful in demonstrating regulators increasing focus on marketing. This will have relevance to products sold by banks - in particular, in relation to ESMA's comments on boilerplate language and cross-references.

Disclosure:

• In relation to pre-contractual disclosures, aspects that NCAs will be reviewing include whether: pre-contractual templates have been properly completed in all their parts; taxonomy alignment disclosures have been included in respect of funds disclosing under Article 5 or 6 of the TR; a description of the manner in which sustainability risks are integrated in the investment decisions and the results of the assessment of the impact of these risks on the returns of the funds is included; and the environmental and or social characteristics promoted by funds disclosing under Article 8 of SFDR are clearly stated and sufficiently explained in the annex.
• For funds with relevant environmental classifications under SFDR disclosure of the criteria for the selection of underlying assets should be limited to those criteria that are binding on the fund manager in the investment decision making process. This is an important aspect where we have seen divergence in practices.
• The ESMA Supervisory Briefing notes that, "[t]he sustainable objectives or characteristics should be clearly identified and expressions such as “the fund pursues ESG objectives in general” without any further specification should be avoided. In case of environmental objectives, a way to clearly identify those objectives is if they are referred to in Article 9 TR." Again this might require amendments to be made by funds who have taken a more broad brush approach.
• For periodic disclosures, NCAs will be looking for whether a prominent statement referring to the information to be found in the annex has been included in the main body of the annual report, and the annual report will need to have been "properly completed in all parts" (ESMA sets out minimum content).
• Sell-side insights: there are some useful notes in the section regarding disclosure that could be referred to or discussed in the context of MiFID II product governance amendments. In particular, disclosure regarding specific products sold by a bank for instance.

Investment strategy:

• The investment strategy of the fund will need to be clearly identified in the relevant fund documentation. The strategy should also clearly state how it is linked to the formulated sustainable objectives or characteristics and how it helps to achieves this.
• For a strategy to be clearly identified, ESMA sets out non-exhaustive key elements that should be disclosed: investment universe (including limits and thresholds); screening criteria applied; specific ESG characteristics/themes or non-financial impacts pursued; use of benchmark/indices and relative expected tracking error (if applicable); and stewardship approach.

Portfolios:

• Portfolio holdings should reflect the name, the investment objective, the strategy and the characteristics shown in the documentation for investors and ESMA encourages NCAs to request explanations and/or documentation to validate claims. The NCA may involve funds' depositaries in the process of analysing the portfolio.

Next steps

Clearly, funds should use this as a check and balance to their current approach. Although the RTS (and therefore the final version of the SFDR templates) do not come into force until next year, this statement is now the benchmark of what we would expect to see.