Key takeaways of ESMA’s risk analysis report on names and claims in the EU fund industry

The European Securities and Markets Authority (ESMA) has published its findings from a study of the use of ESG terms in fund names and fund documents in EU-domiciled investment funds, feeding the debate around greenwashing and highlighting trends reflecting fund managers’ pursuit of investors focused on allocating capital to ESG-related strategies.

The study used natural language processing techniques to survey a deep pool of 36,000 EU-domiciled UCITS fund names and over 100,000 fund-related documents (including documents setting out investment strategies, documents required by regulation, and marketing materials), allowing it to collect data on the use of ESG terms, changes to usage over time, and other related data, such as the variation in usage across different types of documents.

The concept of an ESG term is not fixed, and while there is a consensus that some words and phrases would fall within scope, other terms may be more marginal. The study authors compiled a lengthy list of terms, phrases and abbreviations (1,236 terms for assessing fund names and 3,139 terms for assessing fund documents), drawing from regulatory and policy sources, academic publications, industry sources and expert reviews. These terms formed the basis for the analysis of fund names and documents.

While some of the study’s conclusions come as no surprise (for example, funds disclosing under Article 8 or 9 of SFDR are more likely to use ESG terms in their fund documentation than those disclosing under Article 6), others may be of further interest to ESMA as it assesses the scale and risks of greenwashing in the European market:

1. There was a significant increase in the use of ESG terms in fund names between 2013 and 2022, from 3% of funds to 14%. The increase gained momentum in 2016 (without attributing causality, the study authors note that this followed the Paris Agreement in 2015), accelerating in 2018 until a levelling off at the end of 2022.

The slowdown at the start of 2023 appears to reflect the general decrease in new ESG investment products this year, although it is too early to tell whether this is the start of a change to the upwards trend.

2. An increased use of broad, more generic ESG terms appear to underpin the growth in ESG fund names. Each term assessed in the study was given a category, ranging from specific environmental (E) (e.g., ‘net zero’) and social (S) (e.g., ‘equality’) phrases to broader ESG language (e.g., ‘ESG’ or ‘global impact’). The analysis reflected that in the period over which the use of ESG terms grew, this was driven by the ESG-tagged terms, rather than E- or S-tagged phrases.

It may be that the products connected to the increase in ESG fund names do indeed pursue wide-ranging ESG strategies which can only be captured by broad terminology. However, managers may have latched onto vaguer terms – which are harder to pinpoint as misleading descriptions of the fund portfolio – in order to pursue growing investor appetite for ESG products. By contrast, investors are more able to verify that investments align with the fund name where the fund name uses specific environmental or social terminology. This finding may therefore be of interest to ESMA in its supervisory approach to greenwashing, leading to targeted scrutiny of the strategies and investments of funds with more expansive ESG names.

3. Additional analysis of a subset of the data allowed the authors to analyse the changes to existing fund names. Since 2018, 1,356 of the funds assessed added ESG terms, with the largest number of changes occurring in the second half of 2021 and the first half of 2022. One conclusion drawn from this (combined with data showing the largest flow of investment into funds with ESG names in late 2020 and early 2021) is that managers are using name changes to attract investors looking for ESG products. The question is open as to whether these funds are changing their strategies at the same time.

4. One striking takeaway from the analysis of fund documents is that retail-facing funds appear to use more ESG terms in regulatory documents (e.g., KIIDs) than professional-only funds, but this trend does not extend to other types of documents, which are not standardised or regulated.  Fund managers appear to adapt their communications strategy to the expected types of readers, making proportionally more ESG claims in the documents designed to improve retail understanding. ESMA may follow this conclusion to assess whether certain classes of investor are more exposed to greenwashing, and whether the lack of consistency in the frequency of ESG terms across different types of document indicates a heightened risk of greenwashing.

5. The analysis also indicated that ESG terms were more common in documents relating to funds which invested in equities (rather than bonds or mixed assets) and newer funds.

These findings are likely to inform ESMA’s approach to monitoring greenwashing and developing an anti-greenwashing strategy, building on the consultation on Guidelines on funds’ names using ESG or sustainability-related terms which closed in February 2023 and they emphasise the importance of the topic for ESMA. The study highlights areas of potential concern – in the increased use of vague, less easily verifiable ESG language in fund names, and the disproportionate use of ESG language in retail-facing documents – which ESMA may target.

The study also raises the prospect of ESMA using natural language processing tools to strengthen its supervisory role. Standardised documents, such as KIIDs and disclosures under SFDR, are particularly attractive for analysis using these tools, and this may be a fruitful area for ESMA to explore in its anti-greenwashing efforts.

On a related note, on 3 October 2023, ESMA announced that it would launch a Common Supervisory Action on the integration of sustainability preferences in firms’ suitability assessment and product governance processes and procedures, which will assess how firms collect investors’ sustainability preferences and include sustainability in suitability and target market assessments.

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