What Does "Fair, Clear and Not-Misleading" Mean in the Context of Fund Strategies?

It has been the case for many years that promotional materials in the EU must be “fair, clear, and not mis-leading”. However, how should managers interpret this high-level requirement when describing their approach to ESG matters? We now have some answers.  

The European Securities and Markets Authority (ESMA) has published a second thematic note on sustainability-related claims made by fund managers.  ESMA refers back to the “four principles” identified by European regulators in their work on preventing greenwashing. Sustainability related claims must be (1) accurate, (2) accessible, (3) substantiated, and (4) up to date. But what does that mean in practice for fund managers?

ESMA's thematic note contains practical guidance, including a table setting out a list of Dos and Don'ts, as well as a separate table of good and poor practices. We recommend that all managers who make any sustainability-related statements in their materials review this short (8 page) guidance to see if any action needs to be taken. While this guidance is of particular relevance to managers caught by the EU Sustainable Financial Disclosure Regulation (SFDR), ESMA's practical approach means we think this will be of value to managers in the UK and elsewhere.

ESMA goes into detail by looking at disclosures made by fund managers that address two specific topics:

1. ESG integration
2. ESG exclusions.

ESMA provides examples of divergent practices that it has observed in the market. ESMA states: “These divergent market practices regarding ESG integration and ESG exclusions are often not well explained by market participants, thus creating a risk of claims being misinterpreted and investors being misled in the absence of sufficient transparency. For this reason, the practical do's and don’ts and examples that follow aim to provide useful guidance both to investors and to the market participants making these claims. ”

We highlight some of ESMAs Do's and Don'ts that we think all managers should consider:

ESG Integration:

• Do be clear about:  (i) whether ESG integration is a binding or non-binding aspect of the product’s approach, (ii) whether ESG factors trigger portfolio decisions and if so, if they play a key role in the portfolio construction process or not, (iii) the extent to which they are used in the financial analysis of holdings, iv) their impact on portfolio composition.
• Do clarify at which level ESG integration is done (e.g. at the level of security selection, security weighing, asset allocation).
• Don’t use the term “ESG integration” as an umbrella term to describe a variety of ESG strategies such as exclusions, best in class, etc.
• Don’t use ESG integration as the basis for emphasising the superior sustainability profile of a product, unless this is supported by (i) a key role that ESG factors play in the portfolio construction process, (ii) the extent to which these ESG factors are integrated in financial analysis of holdings, and/ or (iii) their actual impact on portfolio composition.

ESG Exclusions:

• Do describe in plain language the process, the ESG criteria and thresholds used to implement ESG exclusions.
• Do clarify whether ESG exclusions are defined in absolute terms or based on thresholds that apply to all the criteria, or some of them.
• Do be transparent about whether the ESG exclusions strategy relies on a materiality assessment, and if so, whether this is single or double materiality.
• Do be clear about the level of impact of the exclusions on the investable universe and/or on the final portfolio composition, especially if these are negligible.  
• For claims about a product’s use of ESG exclusions, do clarify if the exclusions are defined following a firmwide policy and/or whether they are tailor-made to the product’s investment universe.  
• Don't claim to adopt an ESG exclusions strategy if the exclusion rules are not based on defined criteria and applied consistently.
• Don’t use ESG exclusions alone as the basis for emphasising the superior sustainability profile of funds relative to comparable peers, unless the exclusions will have a significant impact, for example, by materially reducing the universe of intestable assets, or on portfolio composition.  

Please reach out to the authors of this post or your usual Jones Day contact if you would like to discuss.