ESG and Responsible Investment Funds

Following the European Commission (the EC)’s public consultations in 2023 and as part of the EC’s overall review process of the Sustainable Finance Disclosure Regulation (SFDR), the Platform on Sustainable Finance (the Platform), an advisory body to the EC, published on 17 December 2024 a report on the categorisation of products under SFDR, highlighting the potentiality of establishing a categorisation system for sustainable finance products to replace the current de facto classifications under Art. 6, 8 or 9 of SFDR (the Report). The Report mainly aims at mitigating fragmentation due to varying national labelling regimes and different interpretation of SFDR by national competent authorities, auditors and lawyers, while leveraging the positive elements of SFDR and the broader sustainable finance framework. To this end, the Platform’s proposal would simplify product identification for retail investors and financial advisors, and ultimately facilitate investment flows and sustainable economic growth by preventing fragmentation, which affects the passporting regime for investment products. Key elements of the Report The Report recommends categorising financial products as follows: (i) sustainable, (ii) transition, (iii) environmental, social and governance (ESG) collection, and (iv) unclassified products. Such categorisation would be voluntary but should be consistent with investors objective of value-alignment and/or impact. The first two are relevant for investors who seek to invest environment or socially friendly, or in creating change, while the ESG collection category tends to mitigate risks to financial performance caused by ESG factors, depending on the criteria used. The Proposal is centered around retail investors and their values. For each category, the Report sets minimum criteria, indicators to measure, pre-contractual disclosure (which represent the minimum criteria including binding elements and indicators to measure of each category) and reporting. Regarding indicators, the Report inter alia outlines that:these should be measurable and existing indicators already recognised by SFDR should be used, where feasible;the usability of indicators depends on their readiness; andthere needs to be a distinction between the requirement to adhere to binding elements and minimum criteria as a commitment, and the duty to report on performance of certain indicators. (a)    Sustainable This category includes contributions through Taxonomy-aligned investments or sustainable investments with no significant harmful activities, or assets based on a more concise definition consistent with the EU Taxonomy. The minimum criteria for such products are a minimum percentage of capital weighted (revenue, CapEx) and aggregated Taxonomy-aligned and/or sustainable investments (SI) determined based on financial market participants’ (FMP) methodology (FMP SI). FMPs should identify as binding elements of such products the commitment to a minimum of positive contribution identified by Taxonomy alignment and/or FMP SI. It is noteworthy that socially sustainable activities are not yet classified and should be defined by FMPs. The Platform therefore recommends using the previous Platform’s report on a Social Taxonomy, the social principal adverse impact (PAI) indicators, Corporate Sustainability Due Diligence Directive (CSDDD) and the social indicators embedded in the ESRS as a foundation. The Platform also recommends strengthening the concept of both the definition of “sustainable investments” and Do No Significant Harm (DNSH) test and align it with the Taxonomy concept. The Platform recommends that only the Taxonomy dictates activity-based environmentally sustainable investment for all those activities that are eligible. (b)    Transition This category encompasses investments or portfolios supporting the transition to net zero and a sustainable economy, avoiding carbon lock-ins, in line with the EC's recommendations on facilitating finance for the transition to a sustainable economy. The minimum criteria for such products are a specific minimum  proportion of investments that are transitioning and measured with credible transition pathways or plan. Such strategy can also be set at portfolio level. Binding elements may include investments inportfolios tracking EU climate bench­marks,Tax­onomy-aligned economic activ­it­ies,un­der­tak­ings or economic activities with a credible transition plan at the level of the undertaking or at activity level, and/orunder­tak­ings or economic activities with credible science-based targets, where proportionate, that are supported by information ensuring integrity, transparency and accountability. Intermediate activities (meet DNSH thresholds but not substantial contribution) and significantly harmful activities could be eligible for this category, if there is a credible transition plan to transform them. Harmful activities which cannot be transformed should however be excluded from the transition category. (c)    ESG collection Excluding significantly harmful in­vest­ments/activ­it­ies, this category covers investing in assets with better environmental and/or social criteria or applying various sustainability features. It covers all other products with substantial sustainability features that provide for a credible degree of sustainability materiality – aligning to certain values of investors – namely with (i) sustainability features where issuers are selected based on a scoring method, (ii) management towards the improvement of a sustainability indicator either by comparison to a benchmark or by a year-on-year improvement, or (iii) investments in target vehicles or where sub-portfolios are managed in a different way (i.e., by combining different categories and/or different binding elements within a category. In target vehicles). Minimum criteria for such products are at least X% of the investments following one or more material sustainability approach. Binding elements could include (i) a certain percentage better than the reference benchmark or investable universe / year-to-year specified indicators, (ii) an effective reduction of investment universe of at least 20%, (iii) target vehicles or sub-portfolios that are sustainable, transition or ESG collection, or (iv) investments that are eligible for transition or sustainable category. (d)    Unclassified products Any product that is not classified in any other categories shall be “un­clas­si­fied”. Products in this category may still be required to minimum disclosures but will not be required to fulfil minimum criteria as sustainability features. These should namely report on (i) Taxonomy alignment (revenue and capex) and (ii) PAI greenhouse gas (GHG) emission, carbon footprint, GHG intensity of investee companies and UNGPs or OCDE MNEs. Multi-option products might fall under this category. Only client without sustainability preference should be offered unclassified products. What’s next? The Platform advocates to carefully consider an interim solution to facilitate acceptance of a new regime and the possibility of a grandfathering clause, notably in fear of some existing products disclosing under Art. 8 or Art. 9 being “un­clas­si­fied” under the new regime, or changes to the underlying definitions causing some products sold based under the existing rules to no longer adhere to their pre-contractual commitment, or such new categorisation scheme triggering additional information requirements other than those matching the investors’ current understanding of sustainability preferences. The EC is still currently assessing the result of its consultations and working on the review of SFDR, and the Report certainly provides several useful suggestions to this end. The Report remains high-level, but it should serve as a basis to build a complete and detailed categorisation scheme. The Platform recognizes that establishing a categorisation system is a lengthy process and that the Report will most likely require further amendments. Impact assessment, stakeholder feedback and testing will be relevant to define or refine thresholds based on real-world testing. If you have any questions on this topic, please reach out to our experts, Aurélien Hollard, Julie Pelcé or Julien Robert. To read the full Report, please click here.

On 13 December 2024, the European Securities and Markets Authority (ESMA) published answers to frequently asked questions (FAQs) on its Guidelines on funds' names using ESG- or sus­tain­ab­il­ity-re­lated terms (the Guidelines). As market participants have raised several mis­un­der­stand­ings regarding the Guidelines, this first set of answers provided by ESMA is welcomed by the industry. In these three FAQs, ESMA notably clarifies: How to apply the exclusions in case of green bonds Paragraphs 16-18 of the Guidelines require having certain investments excluded from the portfolio of funds with a name using ESG- or sus­tain­ab­il­ity-re­lated terms, referring to the exclusions for the EU Paris-aligned Benchmarks under the Delegated Regulation (EU) 2020/1818 on minimum standards for EU Climate Transition Benchmarks and EU Paris-aligned Benchmarks (the Benchmark Regulation). The question relates to the application of this list of exclusions in case of investments in green bonds and as to whether the screening should be conducted at the level of the issuer or the investments underlying the green bonds. In that respect, ESMA differentiates between (i) European green bonds issued under Regulation (EU) 2023/2631 of the European Parliament and of the Council of 22 November 2023 on European Green Bonds and optional disclosures for bonds marketed as environmentally sustainable and for sus­tain­ab­il­ity-linked bonds (the EU Green Bonds) and (ii) any other green bonds. ESMA clarifies that the list of investments in paragraphs 16-18 referring to the exclusions for the EU Paris-aligned Benchmarks under the Benchmark Regulation of the Guidelines are not applicable to EU Green Bonds, since the Guidelines must be read in conjunction with the above-mentioned regulation and already apply the high level of protection needed for such investments. For other green bonds, the exclusions referred to in paragraphs 16-18 of the Guidelines should apply on a look-through basis to the economic activities financed by such instruments, except for companies under Article 12(1)(c) of the Benchmark Regulation (i.e. companies that benchmark administrators find in violation of the United Nations Global Compact (UNGC) principles or the Organisation for Economic Cooperation and Development (OECD) Guidelines for Multinational Enterprises), such companies being always excluded under the exclusions referred to above.  The interpretation of ‘meaningful investment’ in sustainable investments referred to in Article 2(17) of SFDR As a reminder, investment funds with a name including a “sus­tain­able”-re­lated term are required, under the Guidelines, to invest ‘meaningfully in sustainable investments’ defined under Article 2(17) of SFDR[1]. ESMA clearly confirms that this requirement is met when at least 50% of the portfolio is made of ‘sustainable investments’ within the meaning of Article 2(17) SFDR. However, ESMA clarified that the amount may be higher, subject to the circumstances of the case. The meaning of ‘controversial weapons’ for the purpose of the exclusions As part of the exclusion list of the Benchmark Regulation applicable under the Guidelines, the term ‘controversial weapons’ may be subject to different interpretations. In absence in any clarification in the Benchmark Regulation, ESMA expects that national competent authorities refer to the list included in the principal adverse impact indicators of the SFDR RTS[2] (i.e. anti-personnel mines, cluster munitions, chemical weapons and biological weapons).[1] Art 2(17) of Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sus­tain­ab­il­ity‐re­lated disclosures in the financial services sector (SFDR) according to which ‘sustainable investment’ means an investment in an economic activity that contributes to an environmental objective, as measured, for example, by key resource efficiency indicators on the use of energy, renewable energy, raw materials, water and land, on the production of waste, and greenhouse gas emissions, or on its impact on biodiversity and the circular economy, or an investment in an economic activity that contributes to a social objective, in particular an investment that contributes to tackling inequality or that fosters social cohesion, social integration and labour relations, or an investment in human capital or economically or socially disadvantaged communities, provided that such investments do not significantly harm any of those objectives and that the investee companies follow good governance practices, in particular with respect to sound management structures, employee relations, remuneration of staff and tax compliance[2] Commission Delegated Regulation (EU) 2022/1288

On 15 November 2024, the Luxembourg Commission de Surveillance du Secteur Financier (the CSSF) released a communication to warn the general public about greenwashing risk when investing in financial products. To this end, the CSSF is launching a new dedicated section on its platform www. letzfin. lu (the Letzfin Platform) addressing the growing interest in sustainable financial products and the greater need for awareness. This initiative aims to educate and protect individual investors in the face of increasing green investment opportunities and the potential risks of greenwashing. In its communication, the CSSF defines “gre­en­wash­ing” as “a deceptive practice whereby some companies present themselves as more sustainable than they actually are, misleading investors into believing that their money is being used to benefit the environment, when this is not always the case”. While calling on individual investors to remain vigilant, the CSSF invites them to be critical and not to blindly rely on labels and sustainability promises, and provides several key re­com­mend­a­tions:The fact that the name of a financial product mentions some sus­tain­ab­il­ity-re­lated term does not automatically mean that these characteristics are fulfilled. It is therefore important to thoroughly examine each financial product’s green char­ac­ter­ist­ics;Vague sustainability promises should be scrutinised and sustainability reports should be reviewed to make sure that concrete actions are taken to achieve the stated goals;The credibility of any mentioned green label or certification should be independently verified;A diversified portfolio of investments can help mitigate the risk of exposure to greenwashing; andSeeking advice from financial advisors specialising in sustainability can help investors select the appropriate financial products. On the Letzfin Platform, the new section is designed to provide valuable resources and information to help investors navigate the complexities of sustainable investing, including inter alia educational materials, tools for assessing green investments, and up-to-date information on sustainable finance regulations and best practices. Some key elements are worth noting:1)    On the Letzfin Paltform, the definition of “gre­en­wash­ing” is closely related to the common understanding published by the European Supervisory Authorities in their progress report on greenwashing[1] i.e. “a practice where sus­tain­ab­il­ity-re­lated statements, declarations, actions, or communications do not clearly and fairly reflect the underlying sustainability profile of an entity, a financial product, or financial services.”This definition is broad and covers all types of greenwashing, including unintentional greenwashing, and at different stages of the business cycle of financial products or ser­vices.2)    Explanations on other related terms are also given. For instance, “green­hush­ing” (or “strategic silence”) is used to refer to the refusal to communicate about the true level of sustainability of a product due to the fear of not doing enough or of losing investors fearing lower profitability, whereas “green­wish­ing” refers to the situation where ambitious sustainability goals are set and hardly met by the business. A list of different terms is available on the Letzfin Plat­form.3)    An educational video and set of FAQs are available to address key questions in the investment decision, such as:How to recognize greenwashing? Recommendations focus on the different strategies used (eg. use of misleading terms, inaccurate, vague or incomplete information, lack of concrete proofs, etc.);How can greenwashing be sanctioned? Sanctions are based on misleading commercial practices. However, it is noted that even if the practices are not sanctioned, greenwashing will likely impact the reputation of the entity against which greenwashing allegations are pursued; andHow to assess if a product is really sustainable? Investors are recommended to assess (i) what the sustainable objectives are, (ii) what criteria are used to measure the sustainability, (iii) whether the objectives are really attained, and (iv) whether there is the intervention of a third party to validate the information. Although aiming to be educative and to raise investors’ awareness, the communication of the CSSF confirms the willingness from the regulator to fight against greenwashing behaviours and ensure a sound sustainable financial market within Luxembourg and beyond. To consult the new section on the Letzfin Platform, please click here. If you are interested in sustainability investing and want to engage on this topic, please do not hesitate to reach out to our experts Aurélien Hollard, Julie Pelcé or Julien Robert.[1] ESMA progress report of 1st June 2023 ESMA30-1668416927-2498 Progress Report on Greenwashing

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