ESMA issues second thematic note on sustainability-related claims: ESG strategies

ESMA has issued the second thematic note providing guidance on ensuring sustainability-related claims are clear, fair and not misleading (see our publication on the first note here). This note concentrates on how firms describe ESG strategies: in particular ESG integration and ESG exclusions in non-regulatory communications.

Cross-cutting principles

ESMA reiterates four principles for sustainability claims. They should be:

1. accurate;
2. accessible;
3. substantiated; and
4. up to date.

Focus areas: ESG integration and exclusions

ESMA’s note highlights that ESG integration and ESG exclusions are widely used but inconsistently described, which can mislead investors. This is exacerbated by them being generally less ambitious that other ESG strategy approaches. ESMA describes these at a high level:

• ESG integration: This incorporates material ESG risks/opportunities into investment processes to improve risk-adjusted returns. It may be binding or not, apply to some or all holdings/asset classes, and be based on single or double materiality. It does not imply exclusions.
• ESG exclusions: This uses screens or filters (absolute/relative thresholds) to avoid or limit exposures or to align with norms/values. The impact depends on criteria and thresholds, which can materially shrink (or barely change) the investable universe.

The key distinction being: exclusions state what is prohibited, whereas integration assesses attractiveness using ESG factors without necessarily excluding assets. Its worth noting that ESMA does not aim to formally define these terms.

Observations and areas of divergence

ESMA notes variations within these broad categories that can materially affect investor understanding if not explained clearly.

• Integration: Key variables include whether integration is binding, whether ESG changes trigger action, how ESG factors influence portfolio construction and valuation, and the observable impact on portfolio and tracking error.
• Exclusions: Divergences arise from ambition of thresholds, whether a materiality assessment underpins criteria, and the actual reduction of the investable universe.

Expectations for communications

As with the previous note, ESMA provides “do’s and don’ts” for firms. At a high level:

• ESG integration:
  • Do’s: Define the term; say if it is binding; explain when ESG factors drive decisions and how they affect construction; indicate where it sits in the process; note asset class differences; state single vs. double materiality; describe impact on portfolios.
  • Don’ts: Do not use it as an umbrella label; avoid high-level entity claims without clarity; do not claim integration if neither product nor benchmark implements it; avoid implying superior sustainability solely from integration.
• ESG exclusions:
  • Do’s: Describe process, criteria and thresholds plainly; distinguish absolute vs. relative thresholds; state the materiality basis; be transparent on effect on the investable universe and portfolios, including when negligible.
  • Don’ts: Do not present exclusions without defined, consistent criteria; do not claim superior sustainability unless thresholds are ambitious and effects demonstrable.

ESMA includes examples of good and poor practice, underscoring the need for specificity and warning against vague labels or weak thresholds.

Practical Implications

The note reinforces recent regulatory focus on greenwashing, and ESMA’s earlier note on ESG credentials. Firms should ensure that they have robust processes in place to ensure that their sustainability related claims align with regulatory requirements and expectations, and should specifically consider claims referring to ESG integration and exclusions in light of this guidance.